Computation of Earnings Per Share and Understanding Tax Shields

Homework Assignment #2
GEC Academy PAFB-6302: Corporate Finance and Valuation Deadline: Friday, February 4th, 6:00 PM Beijing Time
Problem 1:
Hitachi Heavy Equipment Manufacturers is planning to repurchase shares of common stock with the proceeds of a $50 MM debt issue. The interest rate of the debt issue is expected to be 10%. Currently, Hitachi is unlevered with 12 MM common shares outstanding. Pre-tax operating income is $30 MM. The equity has a required return of 20%. Assuming the company’s tax rate is 34%, there are no personal taxes, and all cash flows are level perpetuities, answer the following questions:
* Compute the company’s earnings per share, stock price, and market value before the debt issue and stock repurchase.

In $ Millions
Before Debt

In $ Millions
After Debt

EBIT

30

30

Debt

0

50

Interest Rate

0%

10%

Interest Expense

0

5

Earnings

30

25

Tax Rate

34%

34%

Tax Expense

10.2

8.5

Net Income

19.8

16.5

Return to Equity

20%

20%

Value of Equity

99

82.5

Value of Debt

0

17

Firm Value

99

116

Shares Outstanding (millions)

12

6.83

Price

8.25

9.67

EPS

1.65

2.42

Earnings Per Share = $1.65 per share
Stock Price = $8.25
Market Value = $99 Million
* Compute the company’s earnings per share, stock price, market value, and the number of shares repurchased after the debt issue and stock repurchase.
Shares Repurchased = 5.17241379
Earnings Per Share = $2.42 per share
Stock Price (SP) = $9.67
Market Value (MV) = $116 Million
Problem 2:
We showed in class that with corporate and personal taxes the PV(Tax Shields) can be substantially different from TD. Using the formula from class, answer the following questions:
PV tax shields=[1- 1- TC 1- TE 1- TD ] * D
Where TC = Marginal corporate tax rate
TD = Marginal tax rate to bond holders
TE = Marginal tax rate to equity holders
* How does PV (Tax Shields) change (increase or decrease) in response to an increase in TC?
TC and P...