Reliable Gearing currently is all-equity-financed. It has 11,000 shares of equit
ID: 2764967 • Letter: R
Question
Reliable Gearing currently is all-equity-financed. It has 11,000 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 $210,000 with the proceeds used to buy back stock. The high-debt plan would exchange $410,000 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 $210,000? (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 $120,000, what will be earnings per share (EPS) if Reliable borrows $210,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.) EPS $ c. What will EPS be if it borrows $410,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.) EPS $
Explanation / Answer
Number of outstanding share = 11,000
Price of per share = $100
a.
If company borrow $210,000 and use the proceeds in buyback stock.
Total number of stock buyback = $210,000 / $100
= 2,100
After buyback number of share remains = 11,000 – 2,100
= 8,900
Debt equity ratio = (2,100 × $100) / (8,900 × $100)
= 23.59%
Hence debt equity ratio if company borrow $210,000 and use proceeds in buyback stock is 23.59%.
b.
EBIT = $120,000
Interest rate = 11%
Total interest expenses = $210,000 × 11%
= $23,100
Since there is not provision of taxation, so net profit = $120,000 - $23,100
= $96,900
So earning per share is calculated below:
Earnings per share = $96,900 / 8,900
= $10.89
Hence, Earnings per share if company borrow $210,000 and use proceeds in buyback stock is $10.89.
c.
Now if company borrow $410,000 and use proceeds in buyback stock.
Total number of stock buyback = $410,000 / $100
= 4,100
After buyback number of share remains = 11,000 – 4,100
= 6,900
EBIT = $120,000
Interest rate = 11%
Total interest expenses = $410,000 × 11%
= $45,100
Since there is not provision of taxation, so net profit = $120,000 - $45,100
= $74,900
So earning per share is calculated below:
Earnings per share = $74,900 / 6,900
= $10.55
Hence, Earnings per share if company borrow $410,000 and use proceeds in buyback stock is $10.55.