Fli-Bi-Nite Radiology, a company offering radiology services, is considering buying a $4M radiology suite. Depending on the volume of business, the suite is estimated to generate an annual EBIT of between $2, $3, or $4 million. The probabilities of these revenue streams are: 30%, 60% and 10%.
Two financing plans are to be considered. 100% stock, or 55% stock and 45% debt. There are currently 250,000 shares of stock outstanding. Assuming the new stock could be sold for $40 per share, that debt has a 12% interest rate, and the tax rate is 40%; calculate the expected EPS for each scenario. If the P/E ratio is 15, what is the expected price of the stock? Which scenario would you recommend and why?