Hi k9queen!!
Well, finally I found the solution for this nice and very interesting
problem.
Letīs work!!!
16. Total shares outstanding will be:
Alternative I :
At $40 per share to cover $800,000, you need to issue 20,000 new
shares.
The firm has 40,000 shares, so the new amount of shares is 60,000.
Alternative II:
You donīt issue new shares, so the original number of 40,000 doesnīt
change.
The correct answer is c)60,000 under alternative I, and 40,000 under
alternative II.
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17. The total interest obligation will be:
Alternative I:
No new bonds are issued so the original $9,000 ($90,000 at 10%) donīt
change.
Alternative II:
Bonds for $800,000 at 12% coupon rate are issued,
then $800,000 * 0.12 = $96,000 are added to the original $9,000 to
obtain a total of $105,000 of total interest obligation.
The correct answer is b) $9,000 under alternative I, and $105,000
under alternative II.
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18. The indifference level of EBIT is:
EPS = (EBIT - I - T)/ S = (EBIT - I)*(1-T)/ S
where:
EBIT = earnings before interest and taxes
I = interest expenses or interest obligations
T = marginal tax rate
S = number of shares of common stock
"The firm usually has several different alternative sources of funds.
The firm might raise sufficient funds for an investment through debt
or additional common stock. Since interest expenses are generally a
fixed dollar amount once the financing is completed, the equation for
the EPS allows us to graph the relationship between EPS and EBIT. You
can graph the EPS resulting from various levels of EBIT given two
different financial plans for raising funds. One graph shows the
impact of incremental debt financing and the second shows the impact
of incremental equity financing. Notice that the two lines have
different slopes. Conceptually, the difference in slopes is due to
differing degrees of financial leverage between alternatives. The
more highly levered debt alternative will always have the steeper
slope. Mathematically, the difference in slopes is caused by
differing number of shares: under the equity alternative, operating
gains and losses are spread over a greater number of shares.
The point at which the debt and equity lines cross gives the level of
EBIT for which both alternatives result in the same EPS. This point
can be calculated by equating EPS for two different alternatives and
then solving for the indifference level of EBIT."
Source: "Some Indicators of a Firm's Risk and Debt Capacity" by Roger
Clarke and Grant McQueen from Marriott School Brigham Young
University:
http://marriottschool.byu.edu/emp/grm/TeachingNotes/indicators.doc
If EPSe is the EPS for the alternative I (equity financing) and EPSd
is the EPS for the alternative II (debt financing) we have that at the
indifference level EPSe = EPSd, then:
(EBITe - Ie)*(1-T)/Se = (EBITd - Id)*(1-T)/Sd
(EBITe - Ie)/Se = (EBITd - Id)/Sd
(EBIT - $9,000)/ 60,000 = (EBIT - $105,000)/ 40,000
(EBIT - $9,000)]/6 = (EBIT - $105,000)/4
4*(EBIT - $9,000) = 6*(EBIT - $105,000)
4*(EBIT) - $36,000 = 6*(EBIT) - $630,000
2*(EBIT) = $630,000 - $36,000 = $594,000.
EBIT = $594,000 / 2 = $297,000
The correct answer is d) $297,000 .
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19. EPS at the indifference level of EBIT is:
Here the result is indiferent if you use the EPSe or the EPSd, because
at the indifference level of EBIT is EPSe = EPSd .
I will use EPSe (so if you want you can verify the result for EPSd).
EPS = EPSe = (EBIT - Ie)*(1-T)/Se = ($297,000 -
$9,000)*(1-0.34)/60,000 =
= $288,000 * 0.66 / 60,000 =
= $190,080 / 60,000 = $3.17
The correct answer is a) $3.17 .
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I hope this helps, and remember to feel free to post a request of a
clarification if you need it.
Best Regards.
livioflores-ga |
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