The Tiberius Company expects an EBIT of $100,000 every year forever

The Tiberius Company expects an EBIT of $100,000 every year forever. Tiberius can borrow at 10%. Tiberius currently has no debt, and its cost of equity is 14%. If the corporate tax rate is 34%, what is the value of the firm? What will the value be if Tiberius borrows $200,000 and uses the proceeds to buy up stock? Explain your answers and state concisely any assumption you make.

Click here for the solution: The Tiberius Company expects an EBIT of $100,000 every year forever

A company, has EBIT of $2,000,000, total assets of $20,000,000 preferred dividends of $250,000 and is taxed at a rate of 40%

A company, has EBIT of $2,000,000, total assets of $20,000,000 preferred dividends of $250,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment.

Capital Structure debt ratio cost of debt, kd No. of common stock shares required return, ks
0.00% 0.00% 200,000 10.00%
15 8 170,000 11.00%
30 9 150,000 12.00%
45 12 110,000 14.00%
60 15 80,000 18.00%

Calculate earnings per share for each level of indebtedness. Use the grid for the answer
Debt Ratio 0.00% 15.00% 30.00% 45.00% 60.00%
EBIT
Less Interest
EBT
Taxes at 40%
Net Profit
Less Preferred Div
Profits avail. to Common Stockholders
Number of shares
EPS

Use the following equation P0 = EPS/ Rs (Po is the per share value, EPS is the earnings per share and Rs is the required return). Calculate the price per share for each level of indebtedness. Choose the best capital structure. Why?


Click here for the solution: A company, has EBIT of $2,000,000, total assets of $20,000,000 preferred dividends of $250,000 and is taxed at a rate of 40%

Parker Investments has EBIT of $20,000, interest expense of $3,000, and preferred dividends of $4,000

E13-4 Parker Investments has EBIT of $20,000, interest expense of $3,000, and preferred dividends of $4,000. If it pays taxes at a rate of 38%, what is Parker's degree of financial leverage (DFL) at a base level of EBIT of $20,000?

Click here for the solution: Parker Investments has EBIT of $20,000, interest expense of $3,000, and preferred dividends of $4,000

Arrow Technology, Inc. (ATI) has total assets of $10 million and expected operating income (EBIT) of $2.5 million

Arrow Technology, Inc. (ATI) has total assets of $10 million and expected operating income (EBIT) of $2.5 million. If ATI uses debt in its capital structure, the cost of this debt will be 12 percent per annum.

a. Complete the following table:
Leverage ration (debt/total assets)
0% 25% 50%
Total assets
Debt (at 12% interest)
Equity
Total liabilities and equity
Expected operating income (EBIT)
Less: Interest (at 12%)
Earnings before tax
Less: Income tax at 40%
Earnings after tax
Return on equity
effect of 20% decrease In EBIT to $2,000,000
Expected operating income (EBIT)
Less: Interest (at 12%)
Earnings before tax
Less: Income tax at 40%
Earnings after tax
Return on equity
effect of a 20% increase in EBIT to $3,000,000
Expected operating income (EBIT)
Less: Interest (at 12%)
Earnings before tax
Less: Income tax at 40%
Earnings after tax
Return on equity

b. Determine the percentage change in return on equity of a 20 percent decrease in expected EBIT from a base level of $2.5 million with a debt-to-total-assets ratio of
i. 0%
ii. 25%
iii. 50%

c. Determine the percentage change in return on equity of a 20 percent increase expected EBIT from a base level of $2.5 million with a debt-to-total-assets ratio of
i. 0%
ii. 25%
iii. 50%

d. Which leverage ratio yields the highest expected return on equity?

e. Which leverage ratio yields the highest variability (risk) in expected return on equity?

f. What assumption was made about the cost of debt (i.e., interest rate) under the various capital structures (i.e., leverage ratios)? How realistic is this assumption?

Click here for the solution: Arrow Technology, Inc. (ATI) has total assets of $10 million and expected operating income (EBIT) of $2.5 million