Allegra Inc. has one million shares outstanding. The company is considering the issue of debt of $10 million. The interest rate on this new debt issue will be 8%, and the number of shares after the debt issue will be reduced to 500,000. Given a corporate tax rate of 35%, what is the EBIT that will cause the firm's earnings per share to be indifferent between issuing and not issuing debt?

Allegra Inc. has one million shares outstanding. The company is considering the issue of debt of $10 million. The interest rate on this new debt issue will be 8%, and the number of shares after the debt issue will be reduced to 500,000. Given a corporate tax rate of 35%, what is the EBIT that will cause the firm's earnings per share to be indifferent between issuing and not issuing debt?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Cede & Co can borrow at 11 percent. Cede currently has no debt, and the cost of equity is 12 percent. The current value of the firm is $664,000. The corporate tax rate is 30 percent. Required: What will the value be if Cede borrows $223,000 and uses the proceeds to repurchase shares?
Supercool Inc is currently an unlevered firm with 1,000 outstanding shares. It expects togenerate $1,600 in EBIT in perpetuity. The tax rate is 35%. All earnings after tax are paid outas dividends. The firm is considering a capital restructuring for which the company will issue$3,000 of debt to buy back shares. Its cost of debt is 10%. Unlevered firms in the sameindustry have a cost of equity of 20%. The capital restructuring is going to take place onemonth after its announcement. What is the share price of Supercool on the day before andafter the restructuring completion?
Fowler, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 25 percent lower. The firm is considering a debt issue of $60,000 with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. The firm has a tax rate 25 percent. Assume the stock price is constant under all scenarios. a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate…
Farmington Company can borrow at 7.05 percent. The company currently has no debt and the cost of equity is 11.45 percent. The current value of the firm is $660,000. The corporate tax rate is 23 percent. What will the value be if the company borrows $375,000 and uses the proceeds to repurchase shares?
Kaur Resources is an unlevered firm with a total market value of $460,000 and 10, 000 shares of stock outstanding. The firm has expected EBIT of $22, 000 if the economy is normal and $35, 000 if the economy booms. The firm is considering a bond issue of $73, 600 with an attached interest rate of 6.8 percent. The bond proceeds will be used to repurchase shares. The tax rate is 21 percent. What will be the earnings per share after the repurchase if the economy is normal? Multiple Choice $2.02 $1.70 $1.60 $2.62 $1.34
ABC is an unlevered firm with EBIT of $12,257 per year forever. Its unlevered cost of equity is 11%. It plans to borrow $36,348 perpetual debt at 6% to buy back shares. If the corporate tax is 26%, what is the firm value after the recapitalization?
Fujita, Incorporated, has no debt outstanding and a total market value of $422,400. Earnings before interest and taxes, EBIT, are projected to be $55,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 14 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $205,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,800 shares outstanding. Ignore taxes for questions (a) and (b). Assume the company has a market-to-book ratio of 1.0 and the stock price remains constant. a-1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be…

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