Use the following information to answer the questions below. Current cap. struct
ID: 2711468 • Letter: U
Question
Use the following information to answer the questions below.
Current cap. structure
Proposed cap. structure
Assets
$15 million
$15 million
Debt
$0
$6 million
Equity
$15 million
$9 million
Share price
$25.00
$22.50
Shares outstanding
600,000
???
Bond coupon rate
N/A
8%
Assume that there are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market values.
1. How many shares are outstanding under the proposed capital structure?
2. What is the expected EPS under the current capital structure if there is a recession?
3. What is ROE for the proposed capital structure if the expected state occurs?
4. Which of the following is the correct calculation to find EBIT*, the breakeven EBIT
for these two capital structures?
A) EBIT*/400,000 = [EBIT*-($6,000,000x.08)]/600,000
B) [EBIT*-($6,000,000x.08)]/600,000 = EBIT*/400,000
C) EBIT*/600,000 = [EBIT*-($6,000,000x.08)]/400,000
D) [EBIT*-($9,000,000x.08)]/600,000 = EBIT*/400,000
Current cap. structure
Proposed cap. structure
Assets
$15 million
$15 million
Debt
$0
$6 million
Equity
$15 million
$9 million
Share price
$25.00
$22.50
Shares outstanding
600,000
???
Bond coupon rate
N/A
8%
Explanation / Answer
1) shares outstanding = equtiy capital / share price = 9000000/22.5 = 400000
2 ) EPS =( EBIT )/shares outstanding = (2 )/.6 = 3.33
3) ROE = net income/equity = ( EBIT - debt* bond interest rate)/equity = (2.5 - .08*6)/9 = 22.44%
4) for breakeven EPS
EPS plan a = EPS plan b
EBIT/600000 = (EBIT - 6000000*.08)/400000.
option C is correct