Question

Consider a firm with an EBIT of $11,800,000. The firm finances its assets with $52,600,000 debt (costing 7.3 percent) and 11,300,000 shares of stock selling at $8.00 per share. The firm is considering increasing its debt by $26,000,000, using the proceeds to buy back shares of stock. The firm is in the 30 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $11,800,000.

Calculate the EPS before and after the change in capital structure and indicate changes in EPS. (Round your answers to 3 decimal places.)

Answer 1

Before Change in Capital Structure:

Value of Debt = $52,600,000
Interest Rate = 7.3%
Number of shares = 11,300,000

Interest Expense = Value of Debt * Interest Rate
Interest Expense = $52,600,000 * 7.3%
Interest Expense = $3,839,800

After Change in Capital Structure:

Value of Debt = $52,600,000 + $26,000,000
Value of Debt = $78,600,000

Interest Rate = 7.3%

Interest Expense = Value of Debt * Interest Rate
Interest Expense = $78,600,000 * 7.3%
Interest Expense = $5,737,800

Number of shares repurchased = $26,000,000 / $8.00
Number of shares repurchased = 3,250,000

Number of shares = 11,300,000 - 3,250,000
Number of shares = 8,050,000