Problem1. Reliable gearing currently is all-equity-financed. It has 16,000 shares of equity outstanding, selling at the $100 share. The firm is considering the capital restructuring. The low-debt plan calls for debt issue of $350,000 with the proceeds used to purchase back stock. The high-debt plan would exchange $400,000 of debt for the equity. The debt will pay the interest rate of 10.6%. The firm pays no taxes.
Question1. What will be debt to equity ratio after the each contemplated restructuring?
Question2. If earnings before the interest and tax (EBIT) will be either $120,000 or $175,000, what will be earnings per share for each and every financing mix for both probable values of EBIT?
Question3. If both scenarios are equally likely, what is the expected (average) EPS under the each and every financing mix?
Question4. Is high-debt mix preferable?
Assume that EBIT is $169,600. What is EPS under each financing mix?