Question
Lucky Star, Inc. has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $14,000
Lucky Star, Inc. has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $75,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios.
- Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued
- Calculate the percentage changes in EPS when the economy expands or enters a recession
- Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization
- Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession
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