The finance manager of ABX Ltd is considering a recapitalization plan that would convert ABX...
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The finance manager of ABX Ltd is considering a recapitalization plan that would convert ABX from its current all-equity capital structure to one including substantial financial leverage. ABX now has 10,000,000 ordinary shares outstanding, which are selling for $15 each, and the companys EBIT is expected to be $12,000,000 per year for the foreseeable future. The recapitalization proposal is to issue $60,000,000 worth of long-term, perpetual debt at an annual interest rate of 3.0% and use the proceeds to repurchase 4,000,000 ordinary shares worth $60,000,000. Assume perfect capital markets with no market frictions such as corporate or personal income taxes.
a) Calculate the earnings per share and expected return on equity for ABX's shareholders under both the current all-equity capital structure and under the recapitalization plan. Show all calculations.
b) Calculate the breakeven level of EBIT where the earnings per share are the same under the current and proposed capital structures. Show all calculations.
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