Problem:
If a firm has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes are projected to be $10,400 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20% higher. If there is recession then EBIT will be 35% lower. The firm is considering a $42,000 debt issue with a 4% interest rate. The proceeds will be issued to repurchase shares of stock. There are currently 6.25 shares outstanding (ignore taxes for this problem)
Required:
Question 1: Calculate Earnings per Share under each of the economic scenarios before any debt is issued and also calculate the percentage changes in EPS when the economy expands or enters a recession.
Question 2: If a recapitalization occurs what will be observed?
Note: Solve the problem and show all work.