Question

Afro, Inc., has no debit outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 10 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $75,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem.

1. Calculate (EPS) under each of the three economic scenarios before any debt is issued.
2. Calculate the percentage changes in (EPS) when the economy expands or enters a recession.

Given the recapitalization, calculate the percentage changes in (EPS) when the economy expands or enters recession

Answer 1