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

question 87

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:
$$\begin{array} { c c c c } \text { State } & \text { Recession } & \text { Average } & \text { Boom } \\\text { Probability of state } & 0.25 & 0.55 & 0.20 \\\text { Expected EBIT in state } & \$ 5 \text { million } & \$ 10 \text { million } & \$ 17 \text { million }\end{array}$$
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) $0.13
• B) $0.21
• C) $0.27
• D) $0.16

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Definitions:

Implied Authority

The authority of an agent to perform acts that are necessary or customary to carry out expressly authorized duties.

Subagent

An agent appointed by another agent, with the authority to perform tasks or activities on behalf of the original agent's principal.

Nondelegable Duty

A duty that the proprietor cannot delegate, or pass off, to another party.

Actual Warranty

A promise or guarantee provided by a seller regarding the condition and functionality of a product.