Music City, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $40,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $105,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant.

a-1.Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued.

EPS

Recession$

Normal$

Expansion$

a-2.Calculate the percentage changes in EPS when the economy expands or enters a recession.

Percentage changes in EPS

Recession %

Expansion %

b-1.Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.

EPS

Recession$

Normal$

Expansion$

b-2.Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.

Percentage changes in EPS

Recession %

Expansion %