Your Company Doesn't Face Any Taxes and Has $10 Million

question 44

Multiple Choice

Your company doesn't face any taxes and has $10 million in assets, currently financed entirely with equity. Equity is worth $10 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:
$$\begin{array} { c c c c } \text { State } & \text { pessmistic } & \text { optimistic } \\\text { Probability of state } & 0.15 & 0.85 \\\text { Expected EBIT in state } & \$ 2 \text { million } & \$ 8 \text { million } \end{array}$$
The firm is considering switching to a 40 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) $12.73
• B) $11.23
• C) $7.73
• D) $5.00

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Definitions:

Cost of Goods Sold

The direct costs attributable to the production of the goods sold in a company, including material and labor costs.

Schedule of Cost of Goods Manufactured

A detailed report showing the total production costs incurred to produce goods in a specific accounting period.

Total Manufacturing Cost

The aggregate cost of producing goods, including direct labor, direct materials, and manufacturing overhead expenses.

Prime Costs

The direct costs directly attributable to the manufacture of goods, including direct materials and direct labor.