Ferris Manufacturing is all equity financed. Current financial data fo

Ferris Manufacturing is all equity financed. Current financial data for Ferris is provided in the table below for three states of nature, which correspond with three levels of sales.

The CFO of Ferris, Cameron Fry, is considering a change in capital structure. In particular, he is thinking about borrowing $5,000. He will borrow the money by issuing perpetual bonds with a face value of $5,000 and a coupon rate of 5%. The borrowed money will be used to repurchase shares at $28.57 per share. Repurchased shares will be cancelled. Taxes are 0%. What are Earnings per Share (EPS) in each state of nature if Ferris borrows the money?

Ferris Manufacturing
Bad Normal Good
EBIT $500 $1,000 $1,500
Interest 0 0 0
Pre-Tax Income 500 1,000 1,500
Taxes (0%) 0 0 0
Net Income 500 1,000 1,500
# Shares 500 500 500
EPS $1.00 $2.00 $3.00

A) Bad: $1.00; Normal: $2.00; Good: $3.00
B) Bad: $0.77; Normal: $2.31; Good: $3.85
C) Bad: $0.50; Normal: $1.50; Good: $2.50
D) Bad: $1.54; Normal: $3.08; Good: $4.62
E) Bad: $1.25; Normal: $2.25; Good: $4.15

ANSWER

B