Firewall Corp. is a small company looking at two possible capital structures. Currently, the firm is an all-equity firm with $900,000 in assets and 100,000 shares outstanding. The market value of each share is $9.00

The CEO of Firewall is thinking of leveraging the firm by selling $270,000 of debt financing and retiring 30,000 shares, leaving 70,000 shares outstanding. The cost of debt is 6% annually, and the current corporate tax rate for Firewall is 30%. The CEO believes that Firewall will earn $100,000 per year before interest and taxes. Which of the statements below is TRUE?
A) All-equity EPS is $0.70.
B) 30/70 debt-to-equity EPS is $0.838.
C) Shareholders will be better off by almost $0.14 per share under a firm with $270,000 in debt financing versus a firm that is all-equity.
D) Statements A, B, and C are all true.

Answer: D
Explanation: D) Find the EPS under the two financing structures with an EBIT of $100,000:
With All-Equity: EPS = = $0.70
Annual Interest Payment for Debt = $270,000 × 0.06 = $16,200
With 30/70 Debt to Equity: EPS = = $0.838
So the shareholders will be better off by almost $0.14 per share under a firm with $270,000 in debt financing versus a firm that is all equity. The CEO of Firewall Corp. should add debt to the firm as it would benefit the owners of the company.