Trueware Corporation is a start-up firm with a capital structure that includes 25 percent debt. Trueware has no preferred stock. The firm has two possible scenarios for its operations: Ruby or Emerald. The Ruby scenario has a 70 percent probability of occurring and the forecast earnings before interest and taxes (EBIT) in this scenario is $80,000. The Emerald scenario has a 30 percent chance of occurring and the EBIT is expected to be $32,000. Further, the firm's cost of debt is 10 percent. The firm has $500,000 in total assets and its marginal tax rate is 30 percent. The company has 22,000 shares of common stock outstanding. Calculate the difference in earnings per share (EPS) for the capital structure
A)$1.53
B)$1.20
C)$1.48
D)$2.24
E)$3.15

Question

Quizplus · Accepted Answer

The expected EBIT is calculated as (0.7 * $80,000) + (0.3 * $32,000) = $65,600. Interest expense is 10% of $125,000 (25% of $500,000), which is $12,500. Taxable income is $65,600 - $12,500 = $53,100. After-tax income is $53,100 * (1 - 0.3) = $37,170. EPS is $37,170 / 22,000 = $1.69. The difference in EPS between scenarios is calculated by comparing the EPS in each scenario, leading to a difference of $1.53.

Trueware Corporation Is a Start-Up Firm with a Capital Structure