River Cruises is all-equity-financed. Suppose it now issues $250,000 of debt at

Question

River Cruises is all-equity-financed.

Suppose it now issues $250,000 of debt at an interest rate of 10% and uses the proceeds to repurchase 25,000 shares. Assume that the firm pays no taxes and that debt finance has no impact on firm value. Refer to the above table to compute the missing data. (Do not round intermediate calculations. Round "Earnings per share" to 3 decimal places. Enter "Return on shares" as a percent rounded to 2 decimal places.)

Outcomes

Number of shares

Price per share

Market value of shares

Market value of debt

              State of the Economy

                                               Slump              Normal               Boom

Profits before interest             77,500              130,000              191,500

Interest

Equity Earnings

Earnings per share

Return on shares

Current Data Number of shares 100,000 Price per share $ 10 Market value of shares $ 1,000,000 State of the Economy Slump Normal Boom Profits before interest $ 77,500 130,000 191,500

Explanation / Answer

OUTCOMES: Number of shares (100000-25000) 75000 Price per share $           10.00 Market value of shares $     7,50,000 Market value of debt $     2,50,000 STATE OF THE ECONOMY: SLUMP NORMAL BOOM Profit before interest 77500 130000 191500 Interest (250000*10%) 25000 25000 25000 Equity earnings 52500 105000 166500 Earnings per share $              0.70 $             1.40 $          2.22 Return on shares 7.00% 14.00% 22.20%

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