Glass Ornaments, Inc. is an all-equity firm with a total market value of $386,000 and 15,000 shares of stock outstanding. Management is considering issuing $75,000 of debt at an interest rate of 8 percent and using the proceeds on a stock repurchase. As an all-equity firm, management believes the earnings before interest and taxes (EBIT) will be $31,000 if the economy is normal, $11,000 if it is in a recession, and $37,000 if the economy booms. Ignore taxes. What will the earnings per share (EPS) be if the economy falls into a recession and the firm maintains its all-equity status?

Question

Quizplus · Accepted Answer

If Glass Ornaments maintains its all-equity status, its EBIT in a recession will be $11,000. Therefore, the earnings available to shareholders will be:

EBIT - interest = earnings available to shareholders
$11,000 - 0 = $11,000

The earnings available to shareholders can be divided among the 15,000 outstanding shares to find the EPS:

EPS = earnings available to shareholders / number of shares outstanding
EPS = $11,000 / 15,000
EPS = $0.73