Question

# Consider a firm with an EBIT of \$566,000. The firm finances its assets with \$1,160,000 debt...

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

 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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