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A firm's shareholders believe that if its current debt ($2.5 million) were replaced by equity then earnings per share would increase. Assume the debt has a 10% interest rate, the tax rate is 45%, there are 400,000 shares outstanding that sell for $25 a share, and the current EPS is $1.85.
1. Calculate the EPS with no debt.
2. Are the shareholders correct that an all-equity firm would increase EPS?
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