Data Number of shares Price per $20 Market value of shares $2000 Market value of debt Examples of Possible Outcomes Sit 2 Sit 3 (Expected Outcome) Operating income 100 250 300 Earnings per share S 2.5 Return on equity 12.5 The company has no leverage and all the operating income is paid out as dividends to the common stockholders The expected earnings and dividends per share are $2.50. This is an average, actual earnings could turn out to be more or less than $2.50. The price of each share is $20. Since the firm expects to produce a level stream of earnings in perpetuity, the expected return is given by EPS 2.50 Mr. Modigliani, a Harvard MBA and the firms president, has come to the conclusion that shareholders would be better off if the company had equal proportions of debt and equity. He therefore proposes to issue $1000 of debt at the risk free lending and9 Data Number of shares 100 Price per share $20 Market value of shares $2000 Market Value of debt $0 Examples of Possible Outcomes: Sit 1 Sit 2 Sit 3 (Expected Outcome) Operating income $ 100 250 300 Earnings per share $ 1 2.5 3 Return on equity % 5 12.5 15 The company has no leverage and all the operating income is paid out as dividends to the common stockholders. The expected earnings and dividends per share are $2.50. This is an average; actual earnings could turn out to be more or less than $2.50. The price of each share is $20. Since the firm expects to produce a level stream of earnings in perpetuity, the expected return is given by: Mr. Modigliani, a Harvard MBA and the firm's president, has come to the conclusion that shareholders would be better off if the company had equal proportions of debt and equity. He therefore proposes to issue $1000 of debt at the risk free lending and =12.5% 20 2.50 = P EPS r =