30.03.2023 - 11:43

Northwestern savings and loan has a current capital structure consisting of $250,000 of 16% (annual interest) debt and 2,000 shares of common stock. The firm pays taxes at the rate of 40%. a. Using EBIT values of $80,000 and $120,000, determine the associ

Question:

Northwestern savings and loan has a current capital structure consisting of {eq}$250,000 {/eq} of {eq}16% {/eq} (annual interest) debt and 2,000 shares of common stock. The firm pays taxes at the rate of {eq}40% {/eq}.

a. Using EBIT values of {eq}$80,000 {/eq} and {eq}$120,000 {/eq}, determine the associated earnings per share (EPS).

b. Using {eq}$80,000 {/eq} of EBIT as a base, calculate the degree of financial leverage (DFL).

c. Rework parts a and b assuming that the firm has {eq}$100,000 {/eq} of {eq}16% {/eq} (annual interest) debt and 3,000 shares of common stock.

Answers (1)
  • Charlene
    April 12, 2023 в 18:16
    a. The formula for earnings per share (EPS) is: EPS = (EBIT - Interest Expense) x (1 - Tax Rate) / Number of Shares. For EBIT = $80,000: Interest expense = $250,000 x 0.16 = $40,000 EBIT - Interest Expense = $80,000 - $40,000 = $40,000 EPS = ($40,000 x 0.6) / 2,000 = $12 For EBIT = $120,000: Interest expense = $250,000 x 0.16 = $40,000 EBIT - Interest Expense = $120,000 - $40,000 = $80,000 EPS = ($80,000 x 0.6) / 2,000 = $24 b. The degree of financial leverage (DFL) measures the sensitivity of earnings per share (EPS) to changes in earnings before interest and taxes (EBIT). It is calculated as: DFL = EBIT / (EBIT - Interest Expense) For EBIT = $80,000: Interest expense = $250,000 x 0.16 = $40,000 DFL = $80,000 / ($80,000 - $40,000) = 1.33 c. For the new capital structure, the calculations will be as follows: Total debt = $100,000 Total equity = 3,000 x P (where P is the market price per share) Total value of the firm = $100,000 + 3,000P a. For EBIT = $80,000: Interest expense = $100,000 x 0.16 = $16,000 EBIT - Interest Expense = $80,000 - $16,000 = $64,000 EPS = ($64,000 x 0.6) / 3,000 = $12.80 For EBIT = $120,000: Interest expense = $100,000 x 0.16 = $16,000 EBIT - Interest Expense = $120,000 - $16,000 = $104,000 EPS = ($104,000 x 0.6) / 3,000 = $20.80 b. For EBIT = $80,000: Interest expense = $100,000 x 0.16 = $16,000 DFL = $80,000 / ($80,000 - $16,000) = 1.33 Note how the degree of financial leverage (DFL) has not changed despite the change in the capital structure. This is because the ratio of debt to equity (i.e. leverage) is the same for both capital structures (debt/total value).
Do you know the answer?
Not sure about the answer?
Find the right answer to the question Northwestern savings and loan has a current capital structure consisting of $250,000 of 16% (annual interest) debt and 2,000 shares of common stock. The firm pays taxes at the rate of 40%. a. Using EBIT values of $80,000 and $120,000, determine the associ by subject Business, and if there is no answer or no one has given the right answer, then use the search and try to find the answer among similar questions.
Search for other answers
New questions in the category: Business
Authorization
*
*

Password generation