Nonuns Cos Has A 20 Percent Tax Rate And $29,920 Million Inc

Nonuns Cos Has A 20 Percent Tax Rate And Has 29920 Million In Asset

Nonuns Cos. has a 20 percent tax rate and has $29,920 million in assets, currently financed entirely with equity. Equity is worth $30 per share, and the book value of equity is equal to the market value of equity. The firm’s expected values for EBIT depend on the state of the economy with the following probabilities and expected EBITs:

  • Recession: Probability 0.15, Expected EBIT: $5,142,500
  • Average: Probability 0.70, Expected EBIT: $10,846,000
  • Boom: Probability 0.15, Expected EBIT: $17,297,500

The firm is considering switching to a 25 percent debt capital structure, which would require paying a 10 percent yield on perpetual debt. The objective is to determine the expected EPS if the firm adopts this new debt structure, disregarding rounding of intermediate steps but rounding the final answer to two decimal places.

Paper For Above instruction

The capital structure decision of a firm profoundly influences its financial health, risk profile, and shareholder value. In this analysis, we evaluate the expected EPS (Earnings Per Share) of Nonuns Cos if it shifts from an all-equity financing to a mixed debt-equity structure, considering the specified market and economic conditions.

Currently, Nonuns Cos is entirely equity-funded with assets valued at $29,920 million. Its shares are valued at $30 each, and the market value matches the book value of equity hypothesized to be equal to the market value. The firm faces three main economic states—recession, average, and boom—with respective probabilities of 0.15, 0.70, and 0.15. The expected EBIT in these states is $5,142,500, $10,846,000, and $17,297,500, respectively, which entails a calculation of the firm's profitability in various economic scenarios.

If Nonuns Cos adopts a 25% debt capital structure, it will incur interest expenses at a 10% yield on perpetual debt. This shift influences its net income and hence its EPS. The primary task involves calculating the expected EPS after considering the new capital structure, expected EBITs under different states, tax implications, interest costs, and their effect on earnings attributable to shareholders.

Analysis and Calculation

Initially, the analysis requires computing the firm's earnings before interest and taxes (EBIT) for each state, which are already given. To incorporate the impact of debt, we need to determine interest expenses, which are based on the 25% debt ratio and the total assets. The value of debt (D) is 25% of total assets, i.e., D = 0.25 × $29,920 million = $7,480 million.

Interest expense annually = 10% × D = 0.10 × $7,480 million = $748 million.

Next, we need to compute the taxable income in each state by subtracting interest from EBIT:

  • Recession: Taxable income = $5,142,500 - $748 million
  • Average: Taxable income = $10,846,000 - $748 million
  • Boom: Taxable income = $17,297,500 - $748 million

To ensure consistent units, convert EBIT from dollars to millions where appropriate, as assets are in millions:

  • Recession: EBIT = $5,142,500 (or $5.1425 million).
  • Average: EBIT = $10,846,000 (or $10.846 million).
  • Boom: EBIT = $17,297,500 (or $17.2975 million).

Therefore, the taxable incomes are:

  • Recession: $5.1425 million - $0.748 million = $4.3945 million
  • Average: $10.846 million - $0.748 million = $10.098 million
  • Boom: $17.2975 million - $0.748 million = $16.5495 million

Tax rate is 20%, so the net income attributable to shareholders in each state is:

  • Recession: Net income = 80% × $4.3945 million = $3.5156 million
  • Average: Net income = 80% × $10.098 million = $8.0784 million
  • Boom: Net income = 80% × $16.5495 million = $13.2396 million

The weighted expected net income is computed as:

Expected net income = (0.15 × $3.5156 million) + (0.70 × $8.0784 million) + (0.15 × $13.2396 million) = $0.5273 million + $5.6549 million + $1.9859 million = $8.1681 million.

Finally, to determine the expected EPS, divide the expected net income by the number of shares outstanding. The total equity value is $29,920 million divided by $30 per share, which equals 997.333 million shares.

Expected EPS = $8.1681 million / 997.333 million shares ≈ $0.0082 per share.

In conclusion, the expected EPS for Nonuns Cos if it shifts to a 25% debt structure is approximately $0.0082, which indicates a very low earnings per share due to high leverage and significant interest expenses relative to profits. This detailed financial analysis underscores the importance of carefully considering capital structure decisions, factoring in economic conditions, profitability, and risk levels. Such insights are vital for stakeholders aiming to optimize value and ensure sustainable growth.

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