QUESTION :
Stern’s Stews, Inc., is considering a new capital structure. Its
current and proposed capital structures are the following:
CURRENT PROPOSED
Total assets $150 million $150 million
Debt 25 million 100 million
Equity 125 million 50 million
Common stock price $50 $50
Number of shares 2,500,000 1,000,000
Interest rate 12% 12%
Stern’s Stews’ president expects next year’s EBIT to be $20 million, but
it may be 25 percent higher or lower. Ignoring taxes, perform an EBIT/
eps analysis. What is the indifference level of earnings before interest
and taxes? Should Stern’s Stews change its capital structure? Why?
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