Firewall Corp

question 33

Multiple Choice

Firewall Corp.is a small company looking at two possible capital structures.Currently,the firm is an all-equity firm with $900,000 in assets and 100,000 shares outstanding.The market value of each share is $9.00.The CEO of Firewall is thinking of leveraging the firm by selling $270,000 of debt financing and retiring 30,000 shares,leaving 70,000 shares outstanding.The cost of debt is 6% annually,and the current corporate tax rate for Firewall is 30%.The CEO believes that Firewall will earn $100,000 per year before interest and taxes.Which of the statements below is TRUE?

• A)All-equity EPS is $0.70.
• B)30/70 debt-to-equity EPS is $0.838.
• C)Shareholders will be better off by almost $0.14 per share under a firm with $270,000 in debt financing versus a firm that is all-equity.
• D)Statements A,B,and C are all true.

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Definitions:

Firm's Output

The aggregate amount of products or services a company generates within a given timeframe.

Firm's Output

The total amount of goods or services produced by a firm over a given period of time.

Profit Per Unit

The amount of income that a company earns above its costs for producing one unit of a good or service.

Short Run

A period in which at least one input, such as capital, is fixed, allowing only some factors, like labor, to change in quantity.