Straightforward Theatre Company has an EBIT of $1 million per year. The WACC of the firm is 10 percent and the before-tax cost of debt is 4 percent. The debt is risk free and all cash flows are perpetual. The current D/E ratio is 2/3. The corporate tax rate is 20 percent. The new CEO of Straightforward believes that the D/E ratio is too high and would like to reduce it to 1/3.
She will issue stock to repay the debt.
a. What is the impact on the EPS of Straightforward Theatre with this change in the D/E ratio?
b. What is the impact on the cost of equity for Straightforward Theatre?

  • CreatedFebruary 25, 2015
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