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264 PART 3 • STRATEGY IMPLEMENTATION
TABLE 8-6 EPS/EBIT Analysis for Gateway (M = In Millions)
Amount Needed: $1,000 M
EBIT Range: - $500 M to + $100 M to + $500 M
Interest Rate: 5%
Tax Rate: 0% (because the firm has been incurring a loss annually)
Stock Price: $6.00
# of Shares Outstanding: 371 M
Common Stock Financing Debt Financing
Recession Normal Boom Recession Normal Boom
EBIT (500.00) 100.00 500.00 (500.00) 100.00 500.00
Interest 0.00 0.00 0.00 50.00 50.00 50.00
EBT (500.00) 100.00 500.00 (550.00) 50.00 450.00
Taxes 0.00 0.00 0.00 0.00 0.00 0.00
EAT (500.00) 100.00 500.00 (550.00) 50.00 450.00
#Shares 537.67 537.67 537.67 371.00 371.00 371.00
EPS (0.93) 0.19 0.93 (1.48) 0.13 1.21
70 Percent Stock—30 Percent Debt 70 Percent Debt—30 Percent Stock
Recession Normal Boom Recession Normal Boom
EBIT (500.00) 100.00 500.00 (500.00) 100.00 500.00
Interest 15.00 15.00 15.00 35.00 35.00 35.00
EBT (515.00) 85.00 485.00 (535.00) 65.00 465.00
Taxes 0.00 0.00 0.00 0.00 0.00 0.00
EAT (515.00) 85.00 485.00 (535.00) 65.00 465.00
#Shares 487.67 487.67 487.67 421.00 421.00 421.00
EPS (1.06) 0.17 0.99 (1.27) 0.15 1.10
1.6
1.4 Debt
1.2 70% Debt
1.0 70% Stock
0.8 Common Stock
0.6
0.4
0.2
EPS 0.0
–0.2
–0.4
–0.6
–0.8
–1.0
–1.2
–1.4
–1.6
500 100 500
EBIT
Conclusion: Gateway should use common stock to raise capital in recession or normal economic conditions but should use debt financing under boom
conditions. Note that stock is the best alternative under all three conditions according to EAT (profit maximization), but EPS (maximize shareholders’
wealth) is the better ratio to make this decision.