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.
XYZ is currently an all-equity firm with a total market value of $1,000,000. Earnings before
interest and taxes (EBIT) are projected to be $80,000 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. The three states of the economy are equally
likely. XYZ is considering a (perpetual) debt issue of $150,000 with an interest (i.e.,
coupon) rate of 6%. The proceeds will be used to repurchase shares of stock. There are
currently 25,000 shares outstanding. Suppose that XYZ pays no taxes (that is, the tax rate
is 0%).
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.
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