All-Star Production Corporation (APC) is considering a recapitalisation plan that would

convert APC from its current all-equity capital structure to one including substantial financial

leverage. APC now has 10,000,000 ordinary shares outstanding, which are selling for $7.00

each. Expected EBIT of APC is $7,000,000 per year for the foreseeable future.

The recapitalisation proposal is to issue $49,000,000 worth of long-term debt at an

interest rate of 5.0 per cent and use the proceeds to repurchase as many shares as possible

at $7 per share. Assume there are no market frictions such as corporate or personal income

taxes.

a. Calculate the number of shares outstanding, total value of equity and the debt-to-equity

ratio for APC if the proposed recapitalisation is adopted.

b. Calculate the expected return on equity for APC shareholders under the current all-equity

capital structure and under the recapitalization plan.

c. Calculate the expected earnings per share (EPS) and return on equity for APC

shareholders under the current all-equity capitalisation and the proposed mixed

debt/equity capital structure.

d. At what level of EBIT will APC shareholders earn zero EPS under the current and the

proposed capital structures?