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Alternative capital structures: EBIT-EPS analysis

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A start-up firm considering two alternative capital structures: one is conservative and the other aggressive. The conservative capital structure calls for a debt to asset D/A ratio = 0.25 while the aggressive calls for a D/A = 0.75. Once the firm selects its target capital structure, it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a forecasted EBIT of $60,000. The Famine scenario has a forecasted EBIT of $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10%, while if it selects the aggressive capital structure its debt cost will be 12%. The firm will have $400,000 in total assets and will face a 40% tax rate. The book value of equity per share under either scenario is $10.00 per share. What is the difference between the earnings per share for Feast and Famine under the conservative capital structure?

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Solution Summary

Performs EBIT-EPS analysis of two alternative capital structures.

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