Question

Castle, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 20 percent lower. The firm is considering a debt issue of $120,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 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.

Recession:

Normal:

Expansion:

a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession.

b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.

b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.

Answer 1