Castle, Inc., has no debt outstanding and a total market value
of $150,000. Earnings before interest and taxes, EBIT, are
projected to be $28,000 if economic conditions are normal. If there
is strong expansion in the economy, then EBIT will be 20 percent
higher. If there is a recession, then EBIT will be 25 percent
lower. The firm is considering a debt issue of $60,000 with an
interest rate of 7 percent. The proceeds will be used to repurchase
shares of stock. There are currently 10,000 shares outstanding.
Ignore taxes for this problem.
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.)
EPS
Recession $ 3.36
Normal $ 2.8
Expansion $ 2.1
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.
Enter your answers as a percent rounded to the nearest whole
number, e.g., 32.)
Percentage changes in EPS
Recession 4.9 %
Expansion 2.8 %
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.)
EPS
Recession $
Normal $
Expansion $
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. Enter your answers as a percent rounded
to 2 decimal places, e.g., 32.16.)
Percentage changes in EPS
Recession %
Expansion %