Rauchous Resources has traditionally been financed in a most conservative way. The CEO and founder, Rebecca, just does not believe it debt. However, after hearing a consultant discuss the concept of an optimal capital structure, she began to consider new financing options for the company. Rauchous has an expected level of EBIT of $1.5 million, with an estimated standard deviation of $1 million.
a. Given the current capital structure with no debt, what is the probability that Rauchous will have negative earnings per share during the coming year?
b. Rauchous is considering a large share repurchase program to be funded with $10 million of 10 percent debentures. The current price per share of common stock is $50. If this repurchase is undertaken, what is the probability of negative earnings per share during the coming year?