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Reliable Gearing currently is all-equity-financed. It has 12,000
shares of equity outstanding, selling at $100 a share. The firm is
considering a capital restructuring. The low-debt plan calls for a debt
issue of $210,000 with the proceeds used to buy back stock. The
high-debt plan would exchange $500,000 of debt for equity. The debt will
pay an interest rate of 9.8%. The firm pays no taxes.
a.
What will be the debt-to-equity ratio after each contemplated restructuring? (Round your answers to 2 decimal places.)
Debt-to-Equity Ratio
Low-debt plan
High-debt plan
b-1.
If earnings before interest and tax (EBIT) will be either
$65,000 or $185,000, what will be earnings per share for each financing
mix for both possible values of EBIT? (Round your answers to 2 decimal
places.)
Earnings Per Share
EBIT Low-Debt Plan High-Debt Plan
$65,000 $ $
$185,000
b-2.
If both scenarios are equally likely, what is expected
(i.e., average) EPS under each financing mix? (Do not round intermediate
calculations. Round your answers to 2 decimal places.)
Earnings Per Share
Low-debt plan $
High-debt plan
b-3. Is the high-debt mix preferable?
Yes
No
