Question

Reliable Gearing currently is all-equity-financed. It has 23,000 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 $330,000 with the proceeds used to buy back stock. The high-debt plan would exchange $530,000 of debt for equity. The debt will pay an interest rate of 11%. The firm pays no taxes.a. What will be the debt-to-equity ratio if it borrows $330,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Debt-to-equity ratiob. If earnings before interest and tax (EBIT) are $240,000, what will be earnings per share (EPS) if Reliable borrows $330,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.) EPS $c. What will EPS be if it borrows $530,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.) EPS $

Answer 1

a. The debt-to-equity ratio would be 0.168

b. The earnings per share (EPS) if Reliable borrows $330,000 would be of $10.34 per share

c. The earnings per share (EPS) if Reliable borrows $530,000 would be of $10.27 per share

Step-by-step explanation:

a. According to the given data we have the following:

Number of shares=23,000

Share Price=$100

Hence, Total Share Value=23,000*$100=$2,300,000

If debt of $330,000 is taken and equivalent equity is retired, balance equity=$2,300,000-$33,0000=$1,970,000

Therefore, the Debt/Equity ratio would be as follows:

Debt/Equity ratio=$330,000/$1,970,000

Debt/Equity ratio=0.168

b. According to the given data we have the following:

EBIT=$240,000

Interest=0.11*$330,000=$36,300

Hence, Earning after interest and zero taxes=$240,000-$36,300=$203,700

Shares =1,970,000/100=19,700

Therefore, The Earning per share=$203,700/19,700=$10.34

c. According to the given data If he borrows 530000, the equity left =$2,300,000-$530,000=$1,770,000

Number of shares=1,770,000/100=17,700

EBIT=$240,000

Interest=0.11*530,000=$58,300

Hence, Earning after interest and zero taxes=$240.000-$58,300= $181,700

Therefore the Earning per share=$181,700/17,700=$10.27