Reliable Gearing currently is all-equity-financed. It has 14,000 shares of equit
ID: 2762166 • Letter: R
Question
Reliable Gearing currently is all-equity-financed. It has 14,000 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 $240,000 with the proceeds used to buy back stock. The high-debt plan would exchange $440,000 of debt for equity. The debt will pay an interest rate of 11%. The firm pays no taxes.
a. What will be the debt-to-equity ratio if it borrows $240,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Debt-to-equity ratio _______
b. If earnings before interest and tax (EBIT) are $150,000, what will be earnings per share (EPS) if Reliable borrows $240,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
EPS $_________
c. What will EPS be if it borrows $440,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
EPS $_______
Explanation / Answer
Equity Share Capital after buyback stock = $ 1,160,000 and Debt = $ 240,000
a. Debt equity Ratio = Debt / Equity = 240,000 / 1,160,000 = 0.20
b. EBIT = $ 150,000
Interest = $ 26,400
Earnings = $ 123,600
Number of Shares = 11,600
Earning per share = 123600 /11600 = $ 10.65
EPS = $ 10.65
c. EBIT = $ 150,000
Interest = $ 48,400
Earnings = $ 101,600
Number of Shares = 9,600
Earning per share = 101600 /9600 = $ 10.58
EPS = $ 10.58.
The Final Answers:
a = 0.20
b = $ 10.65
c = $ 10.58