Cross City Tunnel (CCT) Ltd currently has 5 million shares on issue each with a market price of $2.50. CCT currently has no debt but is considering changing its capital structure by issuing $3 million of debt and using the entire proceeds to conduct a share buyback. The interest rate on debt is 10% p.a. and the company tax rate is 30%.
(a) Calculate EPS for both the current and the proposed capital structures at a projected EBIT level of $6 million. Which capital structure is preferable if this is the expected level of EBIT?
(b) At what level of EBIT is CCT indifferent between the two capital structures under consideration?
(c) Graph the current and proposed capital structures.