A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount .The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes,this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 50% and the number of shares in circulation is cut by 50% (assuming that the share price remains unchanged with this change in capital structure)?

Question

Quizplus · Accepted Answer

If borrowing and interest expense increase by 50%, the interest expense becomes $375,000. With operating income of $1.5 million, the net income becomes $1,125,000. With the number of shares reduced by 50% to 50,000, EPS becomes $1,125,000 / 50,000 = $22.50.

A Firm Issues 100,000 Equity Shares with a Total Market