Name:
Matric No.:
1.
Suppose your company has 800,000 shares of common stock outstanding, no debt, and a
marginal tax rate of 40%. You need $6,000,000 to finance a proposed project. You are
considering two options:
Sell 200,000 shares of common stock at $30 per share
Borrow $6,000,000 by issuing 10% bonds
a)
Calculate the EPS for each of the financing alternatives if EBIT is expected to be
i)
$2,000,000
ii) $4,000,000
b)
Comment on the results of EPS in (a). What is the breakeven EBIT where neither is better
than the other?
2. A firm can finance its expansion by selling either $5,000,000 of 8% coupon bonds or
$5,000,000 of equity at $20 per share. There are 1 million of shares outstanding.
Taxes are 37%.
What is the Break-even EBIT?
3.
Based on the following information on Levered Company, answer these questions:
a)
If sales increase by 10%, what should happen to operating income?
b)
If operating income increases by 10%, what should happen to EPS?
c)
If sales increase by 10%, what should be the effect on EPS?
Sales (100,000 units)
$1,400,000
Variable Costs
$800,000
Fixed Costs
$250,000
Interest paid
$125,000
Tax rate
34%
Common shares outstanding
100,000
4. Current position of a firm:
Capital:
Debt
0
Common Stock (600,000shares of $10 par)
$6,000,000
Total Capital employed
$6,000,000
EBIT
$2,000,000
Tax
40%
Recapitalization Exercise:
-To retire common stocks, until its capital is 40% debt
-Borrowing cost at 10% interest
-Common stock can be repurchased at $10 per share
What is the current and new EPS?
1