Chapter 17, Problem 4PS

Corporate leverage Reliable Gearing currently is all-equity-financed. It has 10,000 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 $200,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10%. The firm pays no taxes.

1. a. What will be the debt-to-equity ratio if it borrows $200,000?
2. b. If earnings before interest and tax (EBIT) are $110,000, what will be earnings per share (EPS) if Reliable borrows $200,000?
3. c. What will EPS be if it borrows $400,000?