Blue & Co.is an all-equity firm with a total market value of $230 000.The firm has 25 000 shares outstanding.Management is considering issuing $100 000 of debt at an interest rate of 7 per cent and using the proceeds to repurchase shares.Management estimates that the economy will be fairly normal and thus the firm's earnings before interest and taxes (EBIT)will be $60 000.Ignore taxes.What are the anticipated earnings per share (EPS)if the debt is issued?

Question

Quizplus · Accepted Answer

First, we need to calculate the new market value of the firm after issuing debt and using the proceeds to repurchase shares. 
Market value of equity = $230,000 - $100,000 = $130,000 
New shares outstanding = 25,000 - ($100,000/$230,000) = 20,652.17 (rounded to 20,652)

Next, we can calculate the new EPS: 
EBIT = $60,000 
Interest expense = 7% of $100,000 = $7,000 
EBT = $53,000 
EPS = $53,000/20,652 = $3.75

Therefore, the anticipated EPS if the debt is issued is $3.75, which corresponds to choice (C).

Blue & Cois an All-Equity Firm with a Total Market Value of Value