Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below. Jefferson
Jackson
$$\begin{array} { l r r }
& \text { Jefferson } & \text { Jackson } \
\text { Debt } ( 10 \% ) & \$ 200 \text { million } & \$ 100 \text { million } \
\text { Common equity } & \$ 300 \text { million } & \$ 400 \text { million } \
\text { No. shares outstanding } & 15 \text { million } & 20 \text { million }
\end{array}$$
?
Both companies have $500 million in total assets and both have a 40% marginal tax rate. What is the EPS for Jackson at an EBIT level of $50 million?
A) $1.50
B) $1.20
C) $2.00
D) $2.50

Question

Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below. Jefferson
Jackson
$$\begin{array} { l r r } 
& \text { Jefferson } & \text { Jackson } \
\text { Debt } ( 10 \% ) & \$ 200 \text { million } & \$ 100 \text { million } \
\text { Common equity } & \$ 300 \text { million } & \$ 400 \text { million } \
\text { No. shares outstanding } & 15 \text { million } & 20 \text { million }
\end{array}$$
?
Both companies have $500 million in total assets and both have a 40% marginal tax rate. What is the EPS for Jackson at an EBIT level of $50 million?
A) $1.50
B) $1.20
C) $2.00
D) $2.50

Quizplus · Accepted Answer

To calculate the EPS for Jackson at an EBIT level of $50 million, first, we need to calculate the interest expense, which is 10% of the debt. For Jackson, the debt is $100 million, so the interest expense is $10 million ($100 million * 10%). The EBIT is $50 million, so after subtracting the interest expense, the Earnings Before Taxes (EBT) is $40 million ($50 million - $10 million). With a 40% tax rate, the taxes paid would be $16 million ($40 million * 40%), leaving the Net Income at $24 million ($40 million - $16 million). Jackson has 20 million shares outstanding, so the EPS is calculated as Net Income divided by the number of shares, which is $24 million / 20 million shares = $1.20 per share.

Two Companies, Jefferson and Jackson, Are Virtually Identical in All