TPI is considering a $10 million debt issue with a coupon rate of 8%. Assuming that the expansion causes a cash flow increase to $8 million, calculate how this debt issue affects the debt-to-equity ratio, the EPS, dividend per share. Next, calculate the EPS and dividend per share while assuming that the expansion is instead financed with a stock issue.

Thrifty Pet Insurance (TPI) is an all equity firm with 500000 shares outstanding that sell for $40 a share .The firm’s current annual cash flow, before interest and taxes , is $5 million; the firm faces a 40% tax rate and has a 40% dividend payout ratio. Calculate TPI’s earnings per share and dividend per share(multiply EPS by the dividend payout ratio) Solution Part a EPS = (Cash flow before interest and taxes Interest) * (1 tax rate) / Number of shares Or, EPS = ($5,000,000 0) * (1 0.4) / 500,000 = $6.00 Dividend Per Share = EPS * Dividend Payout Ratio = $6.00 * 0.4 = $2.40 TPI is considering a $10 million debt issue with a coupon rate of 8%. Assuming that the expansion causes a cash flow increase to $8 million, calculate how this debt issue affects the debt-to-equity ratio, the EPS, dividend per share. Next, calculate the EPS and dividend per share while assuming that the expansion is instead financed with a stock issue. Solution Part b (1) If expansion is financed through debt Equity Capital = 500,000…

ares * $40 per share = $20,000,000 Debt Capital = $10,000,000 Debt-to-equity ratio = Debt / Equity = $10,000,000 / $20,000,000 = 0.5 times EPS = (New Annual Cashflow before interest and taxes Interest) * (1 tax rate) / Number of shares Or, EPS = ($8,000,000 – $10,000,000 * 0.08) * (1 0.4) / 500,000 = $8.64 Dividend per share = EPS * Dividend payout ratio = $8.64 * 0.4 = $3.456 Solution Part b (2) If expansion is financed through equity EPS = (New Annual Cashflow before interest and taxes Interest) * (1 tax rate) / Number of shares Or, EPS = ($8,000,000 – 0) * (1 0.4) / 500,000 = $9.6 Dividend per share = EPS * Dividend payout ratio = $9.6 * 0.4 = $3.84