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Question: Repeat parts (a) and (b) in Problem

Repeat parts (a) and (b) in Problem 1 assuming the company has a tax rate of 21 percent, a market-to-book ratio of 1.0 before recapitalization, and the stock price changes according to M&M.

Problem 1:
Fujita, Inc., has no debt outstanding and a total market value of $222,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 shares outstanding. Ignore taxes for this problem.
a. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession.
b. Repeat part (a) assuming that the company goes through with recapitalization. What do you observe?


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