The Phoenix Corporation has the following financial statistics:
· expected EBIT next year without new financing $10 million
· expected interest payment next year $ 1.0 million
· company tax rate 36%
· market price of common stock $10
· common shares outstanding 1 million
· You are CFO of this firm. You are considering borrowing an additional $5 million at an interest cost of 9% per year. You will use the funds to repurchase outstanding common stock at the current market price. Of course, this transaction would have no impact on your expected EBIT.
1) Calculate your times interest earned ratio both with and without the new debt financing.
2) Calculate the expected EPS next year, both with and without the new debt financing.
3) Would the M&M theorem identify this as a value-creating move? Why or why not?