North Side,Inc.has no debt outstanding and a total market value of $175,000.Earnings before interest and taxes,EBIT,are projected to be $16,000 if economic conditions are normal.If there is strong expansion in the economy,then EBIT will be 30 percent higher.If there is a recession,then EBIT will be 70 percent lower.North Side is considering a $70,000 debt issue with a 7 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,500 shares outstanding.North Side has a tax rate of 34 percent.If the economy expands strongly,EPS will change by ____ percent as compared to a normal economy,assuming that the firm recapitalizes.

Question

Quizplus · Accepted Answer

Share price = $175,000/2,500 = $70Shares repurchased = $70,000/$70 = 1,000Annual interest = $70,000 × 0.07 = $4,900EPS _Normal = [($16,000 - $4,900)(1 - 0.34)]/(2,500 - 1,000) = $4.884EPS _Expansion = [(16,000(1.3) - 4,900)(1 - .34)]/(2,500 - 1,000) = $6.996Percentage change = ($6.996 - $4.884)/$4.884 = 43.24 percent