Holiday Decor is an all-equity firm with a total market value of $347,000 and12,000 shares of stock outstanding.Management is considering issuing $48,000 of debt at an interest rate of 7 percent and using the proceeds on a stock repurchase.As an all-equity firm,management believes its earnings before interest and taxes (EBIT)will be $33,000 if the economy is normal,$8,000 if it is in a recession,and $41,000 if the economy booms.Ignore taxes.What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status?

Question

Quizplus · Accepted Answer

If the firm maintains its all-equity status, there will be no interest expense to deduct from EBIT to arrive at earnings available to shareholders (EPS). Therefore, EPS in a recession would be:

EPS = (EBIT - 0) / number of shares outstanding
EPS = ($8,000 - 0) / 12,000
EPS = $0.67

Holiday Decor Is an All-Equity Firm with a Total Market