1. 1.

EBIT and leverage [LO 16.1] Attunga Wool Store has no debt outstanding and a total market value of $185 000. Earnings before interest and taxes, EBIT, are projected to be $29 000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 per cent higher. If there is a recession, then EBIT will be 40 per cent lower. The company is considering a $65 000 debt issue with an interest rate of 7 per cent. The proceeds will be used to repurchase shares. There are currently 7 400 shares outstanding. Ignore taxes for this problem.

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

2. Repeat part

(a) assuming that the company goes through with recapitalisation. What do you observe?