Question

Ghost, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 25 percent lower. The company is considering a $125,000 debt issue 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.

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

b1. Computation of EPS (Answers are in bold)

b2. Computation of Change in EPS (Answers are in bold)

3. Computation of Number Shares remaining after repaurchase from proceeds of debt issue

Proceeds from Debt issue = $125000

Market price of Stock = Market value / Shares o/s

Market price of Stock = 220000 / 11000 = $20 per share

Number of shares repurchased = Proceeds from debt issue / Market price = $125000 = 20 = 6250

Number of Shares left = 11000 - 6250 = 4750 Shares

EPS = Net Income / Shares outstanding

% Change in EPS = (Expansion/Recession EPS - Normal EPS) / Normal EPS