Daddi Mac,Inc.,doesn't face any taxes and has $250 million in assets,currently financed entirely with equity.Equity is worth $13 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year,with the possible values of EBIT and their associated probabilities shown as follows:
The firm is considering switching to a 25 percent debt capital structure,and has determined that they would have to pay a 10 percent yield on perpetual debt.What will be the level of expected EPS if they switch to the proposed capital structure?

Question

Quizplus · Accepted Answer

To calculate the expected EPS under the proposed capital structure, we first need to calculate the expected EBIT for each state of economy using the given probabilities:

Expected EBIT = (0.3 x $40 million) + (0.4 x $50 million) + (0.3 x $60 million) = $50 million

Now, we can calculate the expected net income under the proposed capital structure as follows:

EBIT - Interest = EBT
EBT x (1 - Tax Rate) = Net Income

Where, Tax Rate = 0 (as given in the problem)

EBT = $50 million - ($250 million x 10%) = $25 million
Net Income = $25 million

Finally, we can calculate the expected EPS as follows:

Expected EPS = Net Income / Number of shares outstanding
              = $25 million / ($250 million / $13 per share) 
              = $0.27 per share

Therefore, the best choice is (C) $0.27, as it is the expected EPS under the proposed capital structure.