Consider Two Firms That Are Identical in Every Way Except

question 86

Multiple Choice

Consider two firms that are identical in every way except that one has $1,200 of debt and 350 shares of stock outstanding, while the other is all-equity and has 400 shares of stock outstanding. Assume that the debt is a perpetuity with annual coupons at the rate of 7%. What is each firm's earnings per share if EBIT is $5,000? Assume a tax rate of 40%. $$\begin{array} { | c | c | c | } \hline & \text { Leveraged Firm } & \begin{array} { c } \text { All-Equity } \\\text { Firm }\end{array} \\\hline \text { EBIT } & \$ 5,000 & \$ 5,000 \\\hline \text { EPS } & ? & ? \\\hline\end{array}$$

• A)EPS_L = 8.39; EPS_E = 7.50
• B)EPS_L = 8.39; EPS_E = 8.39
• C)EPS_L = 7.50; EPS_E = 7.50
• D)EPS_L = 7.50; EPS_E = 8.39
• E)EPS_L = 8.43; EPS_E = 7.50

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Definitions:

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