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Walker, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if...
Walker, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if economic conditions are normal. If there is an expansion in the economy, then EBIT will be $29,000. If there is a recession, then EBIT will be $12,000. Walker is considering a $66,000 debt issue with a 5% interest rate. The proceeds will be used to repurchase shares of stock (this is known as recapitalization). There are currently 3,000 shares outstanding. Walker has a market-to-book ratio of 1.0.
Topic: Capital Structure and the Effect of Leverage on Earnings
What is the current price per share for the firm's outstanding equity?
1.Calculate earnings per share (EPS) under normal economic conditions before the firm issues any debt. Assume no taxes.
2.Calculate earnings per share (EPS) under the economic expansion before the firm issues any debt. Assume no taxes.
3.Calculate earnings per share (EPS) under the economic recession before the firm issues any debt. Assume no taxes.
4.Calculate the percentage change in EPS under the economic expansion scenario (relative to a normal economy) before any debt is issued. Assume no taxes.
5.Calculate the percentage change in EPS under the economic recession scenario (relative to a normal economy) before any debt is issued. Assume no taxes.
6.Calculate earnings per share (EPS) under normal economic conditions assuming that the firm goes through with the recapitalization. Assume no taxes.
7.Calculate earnings per share (EPS) under the economic expansion assuming that the firm goes through with the recapitalization. Assume no taxes.
8.Calculate earnings per share (EPS) under the economic recession assuming that the firm goes through with the recapitalization. Assume no taxes.
9.Repeat part (g) assuming a corporate tax rate of 35%.
10,Repeat part (h) assuming a corporate tax rate of 35%.
11.Repeat part (i) assuming a corporate tax rate of 35%.
12.Calculate return on equity (ROE) under normal economic conditions before the firm issues any debt. Assume no taxes.
13.Calculate return on equity (ROE) under the economic expansion before the firm issues any debt. Assume no taxes.
14.Calculate return on equity (ROE) under the economic recession before the firm issues any debt. Assume no taxes.
15.Calculate return on equity (ROE) under normal economic conditions assuming that the firm goes through with the recapitalization. Assume no taxes.
16.Calculate return on equity (ROE) under the economic expansion assuming that the firm goes through with the recapitalization. Assume no taxes.
17.Calculate return on equity (ROE) under the economic recession assuming that the firm goes through with the recapitalization. Assume no taxes.
18.Repeat part (p) assuming a corporate tax rate of 35%.
19.Repeat part (q) assuming a corporate tax rate of 35%.
20.Repeat part (r) assuming a corporate tax rate of 35%.
21.What is the break-even EBIT under normal economic conditions between the levered and unlevered capital structures?
