Reliable Gearing currently is all-equity-financed. It has 16,000 shares of equit
ID: 2706899 • Letter: R
Question
Reliable Gearing currently is all-equity-financed. It has 16,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $350,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10.6%. The firm pays no taxes.
What will be the debt-to-equity ratio after each contemplated restructuring? (Round your answers to 2 decimal places.)
If earnings before interest and tax (EBIT) will be either $120,000 or $175,000, what will be earnings per share for each financing mix for both possible values of EBIT? (Round your answers to 2 decimal places.)
Earnings Per Share
If both scenarios are equally likely, what is expected (i.e., average) EPS under each financing mix?(Do not round intermediate calculations. Round your answers to 2 decimal places.)
Suppose that EBIT is $169,600. What is EPS under each financing mix? (Round your answers to 2 decimal places.)
Reliable Gearing currently is all-equity-financed. It has 16,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $350,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10.6%. The firm pays no taxes.
Explanation / Answer
No of Shares 16000 Equity 1,600,000 Interest 10.60% a Low Debt Plan High Debt Plan Debt 350000 400000 Equity 1,250,000 1,200,000 Debt to Equity Ratio 28.00% 33.33% b/1 Net Income EBIT Low Debt Plan High Debt Plan 120000 82900 77600 175000 137900 132600 EPS = Net Income / No of Shares EBIT Low Debt Plan High Debt Plan 120000 5.18125 4.85 175000 8.61875 8.2875 b/2 If both scenarios are equally likely then the EPS is 0.5* EPS1 + 0.5* EPS2 Solution EPS = Net Income / No of Shares Low Debt Plan High Debt Plan 6.9 6.56875 b/3 High Debt is not preferable as the EPS is lower than the low debt plan c Net Income EBIT Low Debt Plan High Debt Plan 169600 132500 127200 EPS = Net Income / No of Shares EBIT Low Debt Plan High Debt Plan 169600 8.28125 7.95