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Ghost, Inc., has no debt outstanding and a total market value of $395,600. Earnings before interest and taxes, EBIT, are projected to be $53,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 13 percent higher. If there is a recession, then EBIT will be 22 percent lower. The company is considering a $195,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,600 shares outstanding. The company has a tax rate of 21 percent, a market-to-book ratio of 1.0, and the stock price remains constant. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer

The EPS for recession, normal, and expansion are $3.7975, $4.8686, and $5.5015, respectively. The percentage change in EPS for expansion is 13% and for recession is -22%. After recapitalization, the EPS under each of the three scenarios is 4360, with a percentage change of -31.17% and 18.42% for recession and expansion, respectively. Let's now calculate the EPS and percentage change under each scenario. Under expansion conditions, the EBIT is calculated as EBIT × 113% = $53,000 × 113% = $59,890. Under recession conditions, the EBIT is calculated as EBIT × 78% = $53,000 × 78% = $41,340. We then proceed to calculate the tax by multiplying the EBT by 21%, and then calculate the net income. Finally, we divide the net income by the number of shares to obtain the EPS values: $3.7975 for recession, $4.8686 for normal, and $5.5015 for expansion. To calculate the percentage change in EPS, we use the formula (Expansion EPS - Normal EPS) ÷ Normal EPS = (5.05 - 4.86) ÷ 4.86 = 13% for expansion and (Recession EPS - Recession EPS) ÷ Recession EPS = (4.86 - 3.79) ÷ 4.86 = -22% for recession. After recapitalization, the market to book ratio (l) is calculated as market value ÷ book value. The book value is found to be $395,600, and the stock price is then calculated by dividing the book value by the number of outstanding shares. After calculating the number of shares repurchased and the number of shares after repurchasing, we obtain the EPS under each scenario: 4360. We then calculate the percentage change in EPS using the same formula as before: (Recession EPS - Recession EPS) ÷ Recession EPS = (4.66 - 6.77) ÷ 6.77 = -31.17% for recession and (Expansion EPS - Normal EPS) ÷ Normal EPS = (8.02 - 6.77) ÷ 6.77 = 18.42% for expansion.