Question

# Castle, Inc., has no debt outstanding and a total market value of \$250,000. Earnings before interest...

Castle, Inc., has no debt outstanding and a total market value of \$250,000. Earnings before interest and taxes, EBIT, are projected to be \$42,000 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 30 percent lower. The firm is considering a debt issue of \$100,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 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. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Recesion \$

Normal \$

Expansion \$

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.)

Recession \$

Normal \$

Expansion \$

a-1Calculation of EPS:

 Recession Normal Expansion EBIT 29,400 42,000 49,560 Less: Interest 0 0 0 Earnings for Equity 29,400 42,000 49,560 Number of Shares 10,000 10,000 10,000 Earnings per Share 2.94 4.2 4.956

b-1Debt issue = \$100,000

Value per share = Market value/Number of shares

= 250,000/10,000 = \$25

Number of share repurchased = 100,000/25 = 4,000 shares

Calculation of EPS:

 Recession Normal Expansion EBIT 29,400 42,000 49,560 Less: Interest 100,000*8% 8,000 8,000 8,000 Earnings for Equity 21,400 34,000 41,560 Number of Shares 6,000 6,000 6,000 Earnings per Share \$3.57 \$5.67 \$6.93

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