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, has no debt outstanding and a total market value of $240,000.
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Castle, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 10 percent higher. If there is a recession, then EBIT will be 25 percent lower. The firm is considering a debt issue of $48,000 with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 20,000 shares outstanding. The firm has a tax rate 35 percent. Assume the stock price remains constant.
a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.
a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession.
b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.
b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.
