1. EBIT and Leverage [LO1] Ghost, Inc., has no debt outstanding and a total market value of $185,000. Earnings before interest and taxes, EBIT, are projected to be $29,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 40 percent lower. The company is considering a $65,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 shares outstanding. Ignore taxes for this problem. a. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Solve problem 3 (context in question 1, no need for sub questions a) nor b))

1. EBIT and Leverage [LO1] Ghost, Inc., has no debt
outstanding and a total market value of $185,000. Earnings
before interest and taxes, EBIT, are projected to be $29,000
if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 30 percent
higher. If there is a recession, then EBIT will be 40 percent
lower. The company is considering a $65,000 debt issue with
an interest rate of 7 percent. The proceeds will be used to
repurchase shares of stock. There are currently 7,400 shares
outstanding. Ignore taxes for this problem.
a. Calculate earnings per share (EPS) under each of the three
economic scenarios before any debt is issued. Also calculate
Transcribed Image Text:1. EBIT and Leverage [LO1] Ghost, Inc., has no debt outstanding and a total market value of $185,000. Earnings before interest and taxes, EBIT, are projected to be $29,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 40 percent lower. The company is considering a $65,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 shares outstanding. Ignore taxes for this problem. a. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate
3. ROE and Leverage [LO1, 2] Suppose the company in
Problem 1 has a market-to-book ratio of 1.0 and the stock
price remains constant.
a. Calculate return on equity (ROE) under each of the three
economic scenarios before any debt is issued. Also calculate
the percentage changes in ROE for economic expansion and
recession, assuming no taxes.
b. Repeat part (a) assuming the firm goes through with the
proposed recapitalization.
c. Repeat parts (a) and (b) of this problem assuming the firm
has a tax rate of 21 percent.
Transcribed Image Text:3. ROE and Leverage [LO1, 2] Suppose the company in Problem 1 has a market-to-book ratio of 1.0 and the stock price remains constant. a. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes. b. Repeat part (a) assuming the firm goes through with the proposed recapitalization. c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 21 percent.
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