Answer All Questions (I will grade any two of them)

Show all your work (use of formula, etc.) in solving the problems. You still need to show your work even if you use the financial calculator to get the answers.

Finance, Inc., currently has no debt outstanding and has a total market value (equity) of $200,000. EBIT is projected to be $15,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 40 percent higher. If there is a recession, then EBIT will be 50 percent lower. Finance is considering a $60,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes.

a. 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.

b. Repeat part (a) assuming that Finance goes through with recapitalization. What do you observe? (Explain it in terms of percentage change in EPS in both cases: without debt and with debt)

c. Find the break-even EBIT. Find the EPS under both cases at break-even EBIT