Control, Inc. has no debt outstanding and a total market value of $100,000. Earnings before interest and taxes, EBIT, are projected to be $6,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 60 percent lower. Control is considering a $40,000 debt issue with a 5 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares. Ignore taxes for this problem.
A. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS when the economy expands or enters a recession.
B. Repeat part A), assuming that Control goes through with the recapitalization.
C. What conclusions do you draw from your analysis?