Problem
River Cruises is all-equity-financed with 100,000 shares. It now proposes to issue $260,000 of debt at an interest rate of 12% and use the proceeds to repurchase 26,000 shares at $10 per share. Profits before interest are expected to be $126,000.
i. What is the ratio of price to expected earnings for River Cruises before it borrows the $260,000?
ii. What is the ratio after it borrows?