Reference no: EM133111740

The financial manager of Ballpoint, Ltd., estimates that she will increase the earnings per share of her presently all-equity-financed firm if she borrows at the going market rate of 8 percent. She estimates that the debt's beta to be 0.3 and the beta of the all-equity firm is 0.8. A return of 12.5 percent is expected on the all- equity firm, the price earnings ratio of 8 is expected to persist, expected operating income is $300,000, and 100,000 shares are outstanding. She plans to replace 40 percent of her equity with debt. She feels the argument is so compelling that she is chopping at the bit to borrow money. "After all," she argues, "the price of debt is not going to get any cheaper. So now is the time to get the value of the shareholders up." If she operates in perfect capital markets in which there are also no corporate and personal income taxes, what reasonable evaluation should you make of her financing scheme? Show all calculations you may make.