North Side, Inc. has no debt outstanding and a total market value of $175,000. Earnings before interest and taxes, EBIT

North Side, Inc. has no debt outstanding and a total market value of $175,000. Earnings before interest and taxes, EBIT, are projected to be $16,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 70 percent lower. North Side is considering a $70,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares outstanding. North Side has a tax rate of 34 percent. If the economy expands strongly, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.    A.  38.80 percent B.  41.26 percent C.  43.24 percent D.  50.45 percent E.  53.92 percent Share price = $175,000/2,500 = $70 Shares repurchased = $70,000/$70 = 1,000 Annual interest = $70,000 × 0.07 = $4,900 EPS Normal = [($16,000 - $4,900)(1 - 0.34)]/(2,500 - 1,000) = $4.884 EPS Expansion = [(16,000(1.3) - 4,900)(1 - .34)]/(2,500 - 1,000) = $6.996 Percentage change = ($6.996 - $4.884)/$4.884 = 43.24 percent

87.

Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Galaxy would have 178,500 shares of stock outstanding. Under Plan II, there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes. What is the breakeven EBIT?    A.  $287,878.78 B.  $298,333.33 C.  $351,111.11 D.  $333,333.33 E.  $341,414.14 EBIT/178,500 = [EBIT - 0.10($1,790,000)]/71,400; EBIT = $298,333.33

88.

ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $480,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 9 percent. Both firms expect EBIT to be $58,400. Ignore taxes. The cost of equity for ABC is _____ percent, and for XYZ it is ______ percent.    A.  12.17; 12.68 B.  12.17; 13.33 C.  12.17; 15.33 D.  12.29; 12.68 E.  12.29; 13.33 ABC: RE = RA = $58,400/$480,000 = 12.17 percent XYZ: RE = 0.1217 + (0.1217 - 0.09) x (1) = 15.33 percent Note: ABC: Equity = $480,000 XYZ: Equity = $240,000; Debt = $480,000 - $240,000 = $240,000; D/E = 1