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.

(c) Suppose the market-to-book ratio is 1. Calculate the ROE.

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.

Answer rating: 100% (QA)

a EPS NI Number of shares outstanding Normal EPS 210005000 420 Expansi... View the full answer