BADABUM INC. has no debt outstanding and a total market value of $500,000. Earnings before interest and taxes, EBIT, are projected to be $50,000. Money is considering a $200,000 debt issue with an 10 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 1,000 shares outstanding. Ignore taxes for this problem.

a. Calculate earnings per share, EPS, before any debt is issued.

b. Repeat part (a) assuming that BADABUM goes through with recapitalization. What do you observe?

c. What is the ROE under point a? What about point b? What do you observe (5 points)

d. Suppose that BADABUM goes through with the recapitalization, but the equity owners prefer the old capital structure, show how they can create the old capital structure (homemade)?