Question

1. Earnings per share analysis. Chloroline Inc. has 2 million shares outstanding and no debt. Earnings before interest and tax (EBIT) are projected to be $15 million under normal conditions, $5 million for a downturn in the economic environment, and $20 million for economic expansion. Chlorine considers a debt issue of $50 million with an 8 percent interest rate. The proceeds would be used to buy back one million shares at the current market price of $50 a share. The corporate tax rate is 40 percent.

a. Calculate Chloroline’s earnings per share (EPS) and return on investment (EPS divided by share price) under the two scenarios, first before any new debt is issued and then after the recapitalization.

b. From your answers to part a, would you recommend that Chloroline goes ahead with the recapitalization?

Answer 1