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International Tele-Space Corporation (ITSC) has two divisions, Telecommunication Services and Aerospace. As of the end of its fiscal year on August 31, 2007, ITSC had 37 million shares outstanding with todays market price of $50.00 and a P/E ratio of 18.50 times. ITSC has $184 million bonds on its balance sheet and the bonds have been rated AA with trading price at their face value. The Company pays the interest payment at the rate of T-bond rate plus the spread based on its bond rating. The current beta for the Company is 1.30 with income tax rate of 35%.

The Company has won a 10-year government contract to produce the latest model of secret space weapon. To accomplish this, ITSC has established a wholly owned division, Space Industrial Complex (SIC), for the production.

The new division will require a $100 million investment. ITSC has already funded $20 million from its internal funds for this investment and is seeking to determine whether the remaining funds should come from its 2007 income or finance it with all equity or a combination of new debt and equity. The Company is also uncertain about the impact of new debt on its bond rating and capital structure, and would like to know which of the following capital structures (debt-equity ratio) as shown in Table-1 would result in highest value for the investment and shareholders.

Table 1 - Relationship Between Spread, Bond Rating, and Capital Structure
D/E	Spread	Rating
0.00%	0.75%	AAA
5.00%	1.00%	AAA
10.00%	1.50%	AA
25.00%	2.00%	A
50.00%	5.75%	B+
75.00%	13.00%	CC
100.00%	25.00%	D

Financial Background

In the past, ITSC had earned pre-tax return of 14.9402% on its total assets and its last year EBIT (2007) was 14.9402%X ($1,134, 000,000) = $169,571,154. Its estimated that the new contract will provide additional pre-tax return of 20% on the new investment. Notwithstanding that this project would bring additional revenue to the Company, however, ITSC wonders that what be the effect of the proposed financing on its share value, cost of capital, debt coverage, credit rating, and earnings per share.

Table 3- Balance Sheet	2007	LIABILITIES	2007
Cash & ST Investments	$13,000,000	Accounts Payable	$105,000,000
Receivables (Net)	$241,000,000	Short Term Debt & Current Portion of Long-Term [1]Debt	$1,000,000
Inventory-Finished Goods and in Progress	$175,000,000	Accrued Payroll	$70,000,000
Progress Payments & Other	($30,000,000)	Other Current Liabilities	$87,000,000
Other Current Assets	$47,000,000	Current Liabilities - Total	$263,000,000
Current Assets - Total	$447,000,000	Long Term Debt	$184,000,000
		Provision for Risks and Charges	$89,000,000
		Deferred Taxes	($57,000,000)
Property, Plant & Equipment - Gross	$396,000,000	Other Liabilities	$127,000,000
Accumulated Depreciation	($218,000,000)	Total Liabilities	$607,000,000
Tangible Other Assets	$70,000,000	Capital Surplus	$207,000,000
Intangible Other Assets	$13,000,000	Other Appropriated Reserves	($63,000,000)
Property, Plant & Equipment - Net	$261,000,000	Retained Earnings	$384,000,000
Other Assets	$427,000,000	Common Equity	$528,000,000
Total Assets	$1,134,000,000	Total Liabilities & Shareholders Equity	$1,134,000,000

Table 4- Income Statement	2007
Net Sales or Revenues	$1,634,571,154
Cost of Goods Sold	($1,102,000,000)
Depreciation, Depletion & Amortization	($35,000,000)
Gross Income	$497,571,154
Selling, General & Admin Expenses	$324,000,000
Operating Income	$4,000,000
Earnings Before Interest & Taxes (EBIT)	$169,571,154
Interest Expense On Debt	$15,725,000
Pretax Income	$153,846,154
Income Taxes	$53,846,154
Net Income After Taxes	$100,000,000

Table 5 Market Information
Securities	Treasuries
	Bills	Bonds
Yields: in 2007	5%	7%
Market Risk Premium	8%	6%

Question:

1. What is the current EPS?
2. What is the EPS for each proposed capital structure?
3. What is the current interest coverage ratio?

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