Reliable Gearing currently is all-equity-financed. It has 30,000 shares of equit
ID: 2784032 • Letter: R
Question
Reliable Gearing currently is all-equity-financed. It has 30,000 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 $400,000 with the proceeds used to buy back stock. The high-debt plan would exchange $600,000 of debt for equity. The debt will pay an interest rate of 12%. The firm pays no taxes.
a. What will be the debt-to-equity ratio if it borrows $400,000? (Round your answer to 2 decimal places.)
b. If earnings before interest and tax (EBIT) are $310,000, what will be earnings per share (EPS) if Reliable borrows $400,000? (Round your answer to 2 decimal places.)
c. What will EPS be if it borrows $600,000? (Round your answer to 2 decimal places.)
Explanation / Answer
Ans.
(a) Further amount raised =1000000$-----------à400000$ debt
------------à600000$ equity
Existing equity = 3000000$
Debt to equity= debt
Equity
=4000000
3600000
=1.12
Less:-Interest (48000)
EBT 262000
Less TAX (NIL)
EAT 262000
NO.OF EQUITY 32000
SHARES ( W.NOTE.1 )
EPS = EAT
NO.OF EQUITY SHARES
EPS = 262000
32000
EPS =8.1875
(C) EBIT 310000
Less:-Interest (72000)
EBT 238000
TAX ( NIL)
EAT 238000
NO.OF SHARES( W.NOTE 2) 30000
EPS = EAT
NO.OF EQUITY SHARES
EPS = 238000
30000
EPS=7.93
Working Note 1:- existing shares 30000 less buy back shares 4000 so 26000 and further shares are issue is 6000 so total number of shares is 26000+6000=32000.
Working Note 2:- existing shares 30000 less buy back shares 4000 so 26000 and further shares are issue is 4000 so total number of shares is 26000+4000=30000.