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XYZ Ltd is proposing to change its capital structure and has asked you for advice. XYZ currently finances its assets with $8,000,000 of debt that

XYZ Ltd is proposing to change its capital structure and has asked you for advice. XYZ currently finances its assets with $8,000,000 of debt that has a fixed 10% interest rate each year. The market value of the firms equity is $5,600,000, based on the current 200,000 shares outstanding. XYZ proposes to raise $2,800,000 more of equity at the current market price and use the proceeds to repay debt (i.e. capital restructuring is assumed). The company tax rate is 30%.

Required:

a. Calculate i) the current share price, ii) the number of shares to issue, and iii) the number of shares outstanding in the market under the proposed capital structure. (2 marks)

b. If XYZ believes that EBIT will remain at $6,400,000, calculate the earnings per share (EPS) under the current capital structure and under the proposed capital structure. (8 marks)

c. Should XYZ change its capital structure or not? Explain your reason for the decision you make. (1 mark)

d. i) Calculate the break-even level (crossover point) of EBIT associated with the two financing plans and ii) find the EPS at the break-even EBIT. (4 marks)

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