4. (20 marks). Assume there is no tax and the book to market ratio equals 1....

 

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4. (20 marks). Assume there is no tax and the book to market ratio equals 1. Current capital structure Debt: zero. Equity: $200,000, total number of shares: 5,000. EBIT: Normal - $21,000; Expansion -20% higher; Recession 25% lower. Proposed capital structure Debt: $50,000. Cost of debt: 8%. Proceeds are used for purchase of equity. (a) Calculate EPS under each of the three economic scenarios before debt is is- sued. Calculate the percentage changes in EPS when the economy expands or contracts with the current capital structure. 1 (b) Repeat part (a) with the proposed capital structure. (c) What is the degree of financial leverage for the proposed structure? 4. (20 marks). Assume there is no tax and the book to market ratio equals 1. Current capital structure Debt: zero. Equity: $200,000, total number of shares: 5,000. EBIT: Normal - $21,000; Expansion -20% higher; Recession 25% lower. Proposed capital structure Debt: $50,000. Cost of debt: 8%. Proceeds are used for purchase of equity. (a) Calculate EPS under each of the three economic scenarios before debt is is- sued. Calculate the percentage changes in EPS when the economy expands or contracts with the current capital structure. 1 (b) Repeat part (a) with the proposed capital structure. (c) What is the degree of financial leverage for the proposed structure?

Answer rating: 100% (QA)

a Calculation of EPS with current capital structure 1 Normal scenario EBIT 21000 EPS EBIT Total number of shares EPS 21000 5000 EPS 420 2 Expansion sc... View the full answer