Consider a firm with an EBIT of $5,000,000. The firm finances its assets with $20,000,000 debt (costing 5 percent) and 70,000 shares of stock selling at $50.00 per share. To reduce the firm's risk associated with this financial leverage, the firm is considering reducing its debt by $5,000,000 by selling an additional 100,000 shares of stock. The firm is in the 40 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain $5,000,000. What is the change in the firm's EPS from this change in capital structure?
A) decrease EPS by $9.29
B) decrease EPS by $18.70
C) decrease EPS by $19.29
D) increase EPS by $2.14

Question

Quizplus · Accepted Answer

The reduction in debt decreases interest expenses, but the increase in shares dilutes EPS. The calculation shows a decrease in EPS by $19.29.

Consider a Firm with an EBIT of $5,000,000