Your Company Faces a 21 Percent Tax Rate and Has

question 94

Multiple Choice

Your company faces a 21 percent tax rate and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 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:
$$\begin{array} { c c c } \text { State } & \text { Pessimistic } & \text { optimistic } & \\\text { Probability of state } & 0.3 & 0.7 \\\text { Expected EBIT in state } & \$ 15 \text { million } & \$ 40 \text { million } \end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

• A) 0.289
• B) 0.643
• C) 0.798
• D) 0.894

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Definitions:

Attitudes

Attitudes are relatively enduring sets of beliefs and feelings toward a person, object, or event, influencing an individual's emotional responses and behaviors.

Self-Perception Theory

A theory suggesting that individuals determine their attitudes and preferences by interpreting the meaning of their own behavior.

Lens Model

A psychological framework used to explain how individuals make judgments under conditions of uncertainty.

Attribution Theory

A concept in psychology that explains how individuals infer the causes of their own and other people's behavior.