Your company is considering a recapitalization plan that wouldconvert it from its current all-equity capital structure to oneincluding financial leverage. Your company now has 10000,000 sharesof ordinary shares outstanding, which are selling at R40 each. Youexpect the company's EBIT to be R50,000,000 per year, for theforeseeable future.
The recapitalization proposal is to issue R100,000,000 worth oflong-term debt, at an interest rate of 6.50%, and use the proceedsto repurchase as many shares as possible, at a price of R40 pershare. Assume there are no market frictions such as corporate orpersonal income taxes.
Required:
1. calculate the number of shares outstanding,the per share price, and the debt-to-equity ratio for the company,if it adopts the proposed recapitalization.
2. calculate the earnings per share(EPS) and the returnon equity for the company shareholders, under both thecurrent-equity capitalization and the proposed mixed debt/equitycapital structure.
3. calculate the break-even level of EBIT, whereearnings per share for the shareholders are the same, under thecurrent and proposed capital structures.
4. at what level of EBIT will your company shareholdersearn zero EPS under the current and proposed capitalstructures?
