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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

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