Company XYZ has $120 million of assets, 100% financed with equity, and that the firm has 6 million shares of stock outstanding valued at $20 per share. Suppose that the company’s management has identified investment opportunities requiring $60 million of new funds and can raise the funds in the following 3 different ways: 1. Strategy 1: Issue $60 million equity. 2. Strategy 2: Issue $30 million equity and borrow $30 million with r = 8%. 3. Strategy 3: Borrow $60 million with r = 8%.
a) Suppose company XYZ has operating earnings of $27 million. Compute the earnings per share for the 3 financing strategies.
b) Suppose company XYZ has operating earnings of $21.6 million. Compute the earnings per share for the 3 strategies.
c) Suppose company XYZ has operating earnings of $14.4 million. Compute the earrings per share for all 3 strategies.
d) If operating risk is measured by the variability of operating earnings per share, what is the relationship between the debt-equity ratio and the risk associated with the earnings per share?