Question

Eastern Markets has no debt outstanding and a total market value of $154,000. Earnings before interest and

taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the

economy, then EBIT will be 27 percent higher. If there is a recession, then EBIT will be 55 percent lower. The

firm is considering a $20,000 debt issue with an interest rate of 6.5 percent. The proceeds will be used to

repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes. What will be the

percentage change in EPS if the economy enters a recessionary period?

A) -62 percent

B) -55 percent

C)-58 percent

D) -71 percent

E) -46 percent

Answer 1

	Normal	Strong Expansion	Recession
EBIT	$           12,000	$         15,240	$         5,400
Interest [20000*6.5%]	$             1,300	$             1,300	$         1,300
EBT [NI as no tax]	$           10,700	$         13,940	$         4,100
Number of shares [2000-20000/77]	1740	1740	1740
[Price per share = 154000/2000 = $77]
EPS	$               6.15	$               8.01	$             2.36
% change in EPS		30%	-71%
Answer: Option [D] -71%