Wing Air, Inc. has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes (EBIT) are projected to be $25,000 if economic conditions are normal. If the economy is strong then EBIT will be 20% percent higher. In the event of a recession, EBIT will be 35% percent lower. Wing Air is considering a $96,000 debt issue with an interest rate of 6% percent. The proceeds of which will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. Ignore taxes for this problem.
- Calculate the earnings per share (EPS) under each of the three scenarios before any debt is issued.
- Calculate the percentage change in EPS when the economy expands or enters a recession.
Market value $250,000
EBIT $25,000
Expansion-EBIT 20%
Recession-EBIT 35%
Debt issue $96,000
Interest rate 6%
Shares outstanding 6,000