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**

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