What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.(Use values in dollar.)

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When the firm uses $1 million of 20% debt to repurchase two-thirds of its stock, it reduces the number of shares outstanding, potentially increasing EPS. The interest expense on the debt is $200,000 (20% of $1 million). The remaining operating income after interest is $1.3 million ($1.5 million - $200,000). If EPS was $2 before the repurchase, the firm had $1.5 million in earnings spread over $0.75 million worth of shares (since $1.5 million / $2 per share = $0.75 million shares). After repurchasing two-thirds of the stock, one-third remains, equating to $0.25 million worth of shares. The new EPS is $1.3 million / $0.25 million = $5.20.

What Happens to an All-Equity Firm's EPS When $1 Million