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)