Question

2 0.25 points Ghost, Inc., has no debt outstanding and a total market value of $356,900. Earnings before interest and taxes, EBIT, are projected to be $50,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 16 percent higher. If there is a recession, then EBIT will be 25 percent lower. The company is considering a $180,000 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,300 shares outstanding. The company has a tax rate of 23 percent, a market-to-book ratio of 1.0, and the stock price remains constant. 8 04:48:30 eBook Print References a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round Intermediate calculations and round your answers to 2 decimal places, e.g. 32.16.) a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

a-1	Recession EPS	3.48
	Normal EPS	4.64
	Expansion EPS	5.38
a-2	Recession Percentage Change in EPS	-25	%
	Expansion Percentage Change in EPS	16	%
b1	Recession EPS	5.46
	Normal EPS	7.91
	Expansion EPS	9.45
b-2	Recession Percentage Change in EPS	-30.97	%
	Expansion Percentage Change in EPS	19.47	%

Explanation

Before recapitalisation

	Normal	Recession	Expansion
EBIT	50000	37500	58000
Less: Interest	0	0	0
Profit Before Tax	50000	37500	58000
Less: Tax 23%	11500	8625	13340
Net Income (1)	38500	28875	44660
Number of shares (2)	8300	8300	8300
EPS (1 / 2)	4.64	3.48	5.38
% Changes in EPS		-25%	16%

After recapitalisation

	Normal	Recession	Expansion
EBIT	50000	37500	58000
Less: Interest (180000/5%)	(9000)	(9000)	(9000)
Profit Before Tax	41000	28500	49000
Less: Tax 23%	9430	6555	11270
Net Income (1)	31570	21945	37730
Number of shares (2) (=8300-180000) / 43)	3993	3993	3993
EPS (1 / 2)	7.91	5.46	9.45
% Changes in EPS		-30.97%	19.47%