Question: Assume no taxes. Current capital structure Debt: zero. Equity: $200,000, total number of shares: 5,000. EBIT: Normal $21,000; Expansion 20% higher; Recession 25% lower. Proposed

Assume no taxes.

Current capital structure

Debt: zero. Equity: $200,000, total number of shares: 5,000. EBIT: Normal $21,000; Expansion 20% higher; Recession 25% lower.

Proposed capital structure Debt: $50,000. Cost of debt: 8%. Proceeds are used for purchase of equity. (a) Calculate EPS under each of the three economic scenarios before debt is issued. Calculate the percentage changes in EPS when the economy expands or contracts.

(b) Repeat part (a) with the proposed capital structure.

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