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Executive Chalk is financed solely by common stock and has outstanding 25 million shares with a market price of $10/share. The firm is considering a capital restructuring. It now announces that it intends to issue $160 million of debt and use the proceeds to buy back common stock. The debt will pay an interest of 10%. The firm pays no taxes. Complete Table 13 for the high debt plan, showing the high debt plan earnings per share (EPS) when earnings before interest and taxes (EBIT) is $20,000,000.00.
Table 13
Reliable Gearing Financing Alternatives
Category All Equity (1) High-Debt(2)
Market Value of Debt 0
Shares of Equity 25,000,000
Equity Share Price $10/share
Market Value of Equity $250,000,000
Debt to Equity 0
EBIT $20,000,000 $20,000,000
INT 0
EBT $20,000,000
Taxes 0
EAT $20,000,000
Shares 25,000,000
EPS $0.80/share
The market price of the stock is not affected by the announcement
We have been given that The firm is considering a capital restructuring.So company can buy back as follow
Since the market price of the shares is $10, the company can buy back:
$160 million/$10
= 16 million shares
After the change in capital structure, the market value of the firm is unchanged:
Equity + Debt = (9 million ยด $10) + $160 million = $250 million
After the change in structure, the debt ratio is:
Debt/(Debt + Equity) = $160 million/$250 million = 0.64
| High Debt | All equity | |
| Market Value of Debt | 160,000,000 | |
| Market Value of Equity | 90,000,000 | 250,000,000 |
| Total | 250,000,000 | 250,000,000 |
| Debt Equity Rati | 160/250 | |
| 0.64 | 0 | |
| EBIT | 20,000,000 | 20,000,000 |
| Less: Interest Payment | 16000000 | 0 |
| EAIBT | 4,000,000 | 20,000,000 |
| Less : Tax | 0 | 0 |
| EAT | 4,000,000 | 20,000,000 |
| No of Shares | 9,000,000 | 25,000,000 |
| EPS | 0.44 | 0.8 |
