Consider Two Firms That Are Identical in Every Way Except

question 42

Multiple Choice

Consider two firms that are identical in every way except that one has $15,000 of debt and 500 shares of stock outstanding, while the other is all-equity and has 650 shares of stock outstanding. Assume that the debt is a perpetuity with annual coupons at the rate of 6%. What is each firms' earnings per share if EBIT is $7,500? Assume a tax rate of 40%. $$\begin{array} { | c | c | c | } \hline & \text { Leveraged Firm } & \begin{array} { c } \text { All-Equity } \\\text { Firm }\end{array} \\\hline \text { EBIT } & \$ 7,500 & \$ 7,500 \\\hline \text { EPS } & ? & ? \\\hline\end{array}$$

• A)EPS_L = 7.92; EPS_E = 7.92
• B)EPS_L = 6.92; EPS_E = 7.92
• C)EPS_L = 6.92; EPS_E = 6.92
• D)EPS_L = 7.92; EPS_E = 6.92
• E)EPS_L = 8.92; EPS_E = 6.92

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Definitions:

Capital Accounts

Financial records that show the ownership equity in a company, including initial capital contributions, retained earnings, and withdrawals by owners.

Outstanding Liabilities

Financial obligations that a company or individual has not yet settled.

Liquidated Assets

Assets that have been converted into cash or cash equivalents by selling them.

Partnership Liability

The legal obligations that partners in a business partnership are subject to, which can include debts, actions of other partners, and contractual obligations.