Question

First two is already answered by me, it was needed by answer question 3, 4, 5, 6.

1. An all-equity firm currently has 1,500,000 shares of stock outstanding and is considering borrowing $5,000,000 at an annual rate of 7% and buying back one-half of those shares. What amount of annual interest would the firm pay on this borrowing?

B. answer

$350,000

2. An all-equity firm currently has 3,000,000 shares of stock outstanding and is considering borrowing $8,000,000 at 6%

B. answer is

$960,000

and buying back one-half of those shares. What is the break-even EBIT assuming a tax rate of zero?

3. For the firm in #2 what is its EPS (a) before; and (b) after borrowing the $8,000,000 if its tax rate is zero and its EBIT is $1,000,000?

A.

$0.35 $0.33

B.

$0.24; $0.24

C.

$0.35; $0.48

D.

$0.33; $0.35

4. For the firm in #2 what is its EPS (a) before; and (b) after borrowing the $8,000,000 if its tax rate is zero and its EBIT is $600,000?

A.

$0.60; $0.80

B.

$0.80; $0.60

C.

$0.20; $0.08

D.

$0.08 $0.20

5 If the company described in questions 1 - 4 expects its annual EBIT to be a constant $1,000,000 for the foreseeable future, should it undertake the capital restructuring?

A.

No, because the EBIT is below the break-even EBIT.

B.

No, because the EPS is above the EBIT.

C.

Yes, because the EPS is equal to the EBIT.

D.

Yes, because the EBIT is above the break-even EBIT.

6. If the company in questions 1 - 4 expects its annual EBIT to be a constant $700,000, for the foreseeable future, should it undertake the capital restructuring?

A.

Yes, because the EPS is equal to the break-even EBIT.

B.

Yes, because the EBIT is above the break-even EBIT.

C.

No, because the EBIT is below the break-even EBIT.

D.

No, because the EPS is above the break-even EBIT.

just answer number 3,4,5,6

Answer 1

1.Annual Interest Rate = Amount of Loan*Interest rate

= 5,000,000*7% = $350,000

2.Break even EBIT is the level at which EPS under both the alternatives are equal

Let it be x

x/3,000,000 = (x-8,000,000*6%)/1,500,000

x/3,000,000 = (x-480,000)/1,500,000

x = $960,000

3.EBIT = $1,000,000

Before borrowing

EPS = 1,000,000/3,000,000

= $0.33

After Borrowing = (1,000,000-480,000)/1,500,000

= $0.35

Hence, the answer is

D

4.Before borrowing = 600,000/300,000

= $2

After Borrowing = (600,000-480,000)/1,500,000

= $0.08

Hence, the answer is C

5. D.

Yes, because the EBIT is above the break-even EBIT.

6. C.

No, because the EBIT is below the break-even EBIT.