Problem:
A firm has 9k shares of equity outstanding and a market price of $100. The company does not have any debt and management is looking at 2 alternative recapitalization plans. The 1st one calls for issueing $200k of debt. The 2nd calls for issuing $400k of debt. The proceeds from the issuance would be used to purchase equity shares at market price. The cost of debt is 8% per year and ht ecompany does not pay any taxes.
1: If EBIT is equal to $100k what would EPS be under each of the two plans? What does it confirm?
2: If EBIT is either $90k or $150k what would be the company's EPS at both levels for the 2 refinancing plans? If both income possibilities are equally likely so that the expected EBIT is $130k what would be the EPS?