Daddi Mac, Inc The Firm Is Considering Switching to a 25 Percent Debt

question 37

Multiple Choice

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c c } \text { State } & \text { Recession } & \text { Average } & \text { Boom } \\\text { Probability of state } & 0.05 & 0.25 & 0.70 \\\text { Expected EBIT in state } & \$ 5 \text { million } & \$ 10 \text { million } & \$ 17 \text { million }\end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

• A) $0.19
• B) $0.59
• C) $0.41
• D) $0.27

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Definitions:

Oxidation Number

A figure that represents the total number of electrons an atom either gains or loses in order to form a chemical bond with another atom.

Oxidation Number

A value that represents the total number of electrons that an atom either gains or loses in order to form a chemical bond with another atom.

Cl

Symbol for Chlorine, a reactive, yellow-green gas at room temperature, belonging to the halogen group in the periodic table, with applications in water purification, disinfectants, and bleach.

Elemental Metals

A group of elements that share properties such as high electrical conductivity, malleability, and a shiny appearance.