Coaching Limited is being set-up with no debt and it will have a total market value of $800 000. Earnings before interest and taxes (EBIT) are projected to be $96 000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 25 per cent higher. If there is a recession, then EBIT will be 50 per cent lower. Coaching is also considering a $400 000 debt issue with an 8 per cent interest rate. If the debt issue goes ahead, fewer shares will be issued. The original plan is to issue 800 000 shares and no debt.
a. Calculate earnings per share (EPS) under each of three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS if the economy expands or enters a recession.
b. Repeat part (A) assuming Coaching goes through with its plan to issue debt. What do you observe? Ignore taxation in your answer.