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Suppose a company has no debt outstanding and a total market value of $90,000. Earnings before interest and taxes, EBIT, are projected to be $8,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. The company is considering a $34,000 debt issue with a 6 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 3,600 shares outstanding. Ignore taxes for this problem.
**SHOW YOUR WORK**
a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS when the economy expands or enters a recession.
b. Repeat part (a) assuming that the company goes through with recapitalization. What do you observe?
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