Suppose you work for Shah Corporation as a Chief Financial Officer (CFO). The firm has no debt outstanding. Total market value of the firm is $5,977,000. Earnings before interest and taxes, EBIT, are projected to be $393,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20% higher. If there is a recession, then EBIT will be 30% lower. Shah Corporation is considering a $1,175,000 debt issue with a 6% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 96,000 shares outstanding. The tax rate is 35%.

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 the company goes through with recapitalization. What do you observe?