Homework SourseConsider a firm with an EBIT of 869000 The firm finances its
Consider a firm with an EBIT of $869,000. The firm finances its assets with $2,690,000 debt (costing 8.3 percent) and 590,000 shares of stock selling at $5.00 per share. To reduce the firm’s risk associated with this financial leverage, the firm is considering reducing its debt by $1,000,000 by selling an additional 390,000 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 $869,000.
Calculate the EPS before and after the change in capital structure and indicate changes in EPS. (Negative answer should be indicated by a minus sign. Round your answers to 5 decimal places.)
| Consider a firm with an EBIT of $869,000. The firm finances its assets with $2,690,000 debt (costing 8.3 percent) and 590,000 shares of stock selling at $5.00 per share. To reduce the firm’s risk associated with this financial leverage, the firm is considering reducing its debt by $1,000,000 by selling an additional 390,000 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 $869,000. |
Solution
EPS Before change in Capital Structure.
EPS after capital structure changes
EPS before = 0.6566
EPS after = 0.4461
Difference = 0.2105
| EBIT | 869000 |
| Less: Interest (2690000x8.3%) | 223270 |
| 645730 | |
| Less: Tax @ 40% | 258292 |
| Earnings available to shareholders | 387438 |
| No. Shares | 590000 |
| EPS | 0.6566 / Share (387438/590000) |
