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Instructions

Pease answer the following questions. You MUST show work to earn credit.

Based on Chapter $16$:

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Problem $1$: $(20$ points$)$

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XYZ$,$ Inc. has no debt outstanding and has a total market value of $$200,000.$

If the economy is normal, Earnings Before Interest and Taxes $($EBIT$)$ are projected to be $$16,000.$ If there is a strong expansion in the economy, EBIT will be $20\%$ higher, and if the economy falls into a recession, EBIT will be $25\%$ lower than normal.

XYZ is considering a $$50,000$ debt issue with an interest rate of $6\%.$ The proceeds will be used to repurchase shares of stock. Let the stock price be constant under all scenarios. Ignoring taxes, and assuming XYZ currently has $8,000$ shares of stock outstanding, answer the following questions:

Compute the Earnings Per Share $($EPS$)$ under each of the three economic scenarios.

Also compute the percentage changes in EPS when the economy expands, and enters a recession.

Repeat part $$a$$ assuming XYZ goes through with the capitalization. What can you say about the recapitalization?

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Problem $2$: $(20$ points$)$

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Bryzysky corporation has debt$-$equity ratio of $1\mathrm{.}2.$ Its WACC is $7\%,$ and its cost of debt is $4\%.$ Answer the following questions assuming the corporate tax rate is $21\%.$

What is Bryzysky$$s cost of equity capital?

What is Bryzyzky$$s unlevered cost of equity capital?

What would the cost of equity be if the debt$-$equity ratio were

$2?$

$1?$

$0?$

Comment on your answers.