Principles of Corporate Finance
13th Edition
ISBN: 9781260465099
Author: BREALEY, Richard
Publisher: MCGRAW-HILL HIGHER EDUCATION
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Chapter 17, Problem 4PS
Corporate leverage Reliable Gearing currently is all-equity-financed. It has 10,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $200,000 with the proceeds used to buy back stock. The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10%. The firm pays no taxes.
- a. What will be the debt-to-equity ratio if it borrows $200,000?
- b. If earnings before interest and tax (EBIT) are $110,000, what will be earnings per share (EPS) if Reliable borrows $200,000?
- c. What will EPS be if it borrows $400,000?
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Leverage and Earnings. Reliable Gearing currently is all-equity-financed. It has 10,000 sharesof equity outstanding, selling at $100 a share. The firm is considering a capital restructuring.The low-debt plan calls for a debt issue of $200,000 with the proceeds used to buy back stock.The high-debt plan would exchange $400,000 of debt for equity. The debt will pay an interestrate of 10%. The firm pays no taxes. (LO16-1)a. What will be the debt-to-equity ratio if it borrows $200,000?b. If earnings before interest and tax (EBIT) are $110,000, what will be earnings per share(EPS) if Reliable borrows $200,000?c. What will EPS be if it borrows $400,000?
Reliable Gearing currently is all-equity-financed. It has 27,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a debt issue of $370,000 with the proceeds used to buy back stock. The high-debt plan would exchange $570,000 of debt for equity. The debt will pay an interest rate of 12%. The firm pays no taxes.
a. What will be the debt-to-equity ratio if it borrows $370,000? (Round your answer to 2 decimal places.)
b. If earnings before interest and tax (EBIT) are $280,000, what will be earnings per share (EPS) if Reliable borrows $370,000? (Round your answer to 2 decimal places.)
c. What will EPS be if it borrows $570,000? (Round your answer to 2 decimal places.)
Assumptions: A company pays 20% income tax. The company is debt-free and its shareholders' return is 10%. The market value of the total share capital is 100 million. The company's management is thinking about changing the capital structure and debting the company for 50 million and using the proceeds of the loan to buy half of the outstanding shares at market value. The interest rate on the loan would be 7%.
Question 5. What would be the theoretical total value of the company, V, (enterprise value) after the debt? a. 95 million b. 100 million c. 105 million d. 110 million
Question 6. What would be the shareholders' required rate of return, rE, after the leverage? a. 9% b. 10% c. 11% d. 12%
Question 7. What would be the company's cost of capital (WACC after tax) after the leverage? a. 8.8% b. 9.1% c. 9.5% d. 10.0%
Chapter 17 Solutions
Principles of Corporate Finance
Ch. 17 - Homemade leverage Ms. Kraft owns 50,000 shares of...Ch. 17 - Homemade leverage Companies A and B differ only in...Ch. 17 - Corporate leverage Suppose that Macbeth Spot...Ch. 17 - Corporate leverage Reliable Gearing currently is...Ch. 17 - MMs propositions True or false? a. MMs...Ch. 17 - MMs propositions What is wrong with the following...Ch. 17 - Prob. 7PSCh. 17 - MM proposition 1 Executive Cheese has issued debt...Ch. 17 - Prob. 9PSCh. 17 - Prob. 10PS
Ch. 17 - MM proposition 2 Spam Corp. is financed entirely...Ch. 17 - MM proposition 2. Increasing financial leverage...Ch. 17 - Prob. 13PSCh. 17 - MM proposition 2 Look back to Section 17-1....Ch. 17 - MM proposition 2 Hubbards Pet Foods is financed...Ch. 17 - MM proposition 2 Imagine a firm that is expected...Ch. 17 - MM proposition 2 Archimedes Levers is financed by...Ch. 17 - MM proposition 2 Look back to Problem 17. Suppose...Ch. 17 - Prob. 19PSCh. 17 - After-tax WACC Gaucho Services starts life with...Ch. 17 - After-tax WACC Omega Corporation has 10 million...Ch. 17 - After-tax WACC Gamma Airlines has an asset beta of...Ch. 17 - Prob. 23PSCh. 17 - Investor choice People often convey the idea...Ch. 17 - Investor choice Suppose that new security designs...
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