Your Company Has a 21 Percent Tax Rate and Has

question 89

Multiple Choice

Your company has a 21 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 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:
$$\begin{array} { c c c c } \text { State } & \text { Recession } & \text { Average } & \text { Boom } \\\text { Probability of state } & 0.05 & 0.70 & 0.25 \\\text { Expected EBIT in state } & \$ 5 \text { million } & \$ 20 \text { million } & \$ 50 \text { million }\end{array}$$
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

• A) $0.32
• B) $0.14
• C) $0.39
• D) $0.95

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Definitions:

Fair Value

An estimate of the price at which an asset or liability could be traded in a current transaction between willing parties, other than in a forced or liquidation sale.

Goodwill

represents the excess of the purchase price over the fair value of the net assets of the acquired company in a business combination.

NCI

Non-Controlling Interest, a line item on the consolidated balance sheet that reflects the equity in a subsidiary not attributable directly or indirectly to the parent company.

Consolidation Approach

An accounting method used where a parent company combines its financial statements with those of its subsidiaries as if they comprise a single entity.