Question

Consider a firm with an EBIT of $566,000. The firm finances its assets with $1,160,000 debt (costing 6 percent) and 216,000 shares of stock selling at $16.00 per share. The firm is considering increasing its debt by $900,000, using the proceeds to buy back 91,000 shares of stock. The firm is in the 40 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $566,000. Calculate the change in the firm’s EPS from this change in capital structure

Answer #1

Ans. |
The change in capital
structure would increase the EPS by $0.74463. |
|||||||

Change in EPS = After capital structure change - Before capital structure change | ||||||||

2.12352 - 1.37889 | ||||||||

0.74463 | ||||||||

Before |
After |
|||||||

EBIT | 566000 | 566000 | ||||||

Less: Interest | 69600 | 123600 | ||||||

EBT | 496400 | 442400 | ||||||

Less: Tax @40% | 198560 | 176960 | ||||||

Earning after tax | 297840 | 265440 | ||||||

Divide: No. of shares | 216000 | 125000 | ||||||

EPS | 1.37889 | 2.12352 | ||||||

*Calculation: | ||||||||

Before | After | |||||||

Interest | 1160000*6% | (1160000+900000) * 6% | ||||||

No. of shares | 216000 | (216000 - 91000) | ||||||

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