Wing Air, Inc. has no debt outstanding and a total market value of $250,000. Ear

Question

Wing Air, Inc. has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes (EBIT) are projected to be $25,000 if economic conditions are normal. If the economy is strong then EBIT will be 20% percent higher. In the event of a recession, EBIT will be 35% percent lower. Wing Air is considering a $96,000 debt issue with an interest rate of 6% percent. The proceeds of which will be used to repurchase shares of stock. There are currently 6,000 shares outstanding.

Calculate the earnings per share (EPS) under each of the three scenarios before any debt is issued. Assume a 30% tax rate.

Calculate the percentage change in EPS when the economy expands or enters a recession. Assume a 30% tax rate.

30%  

Market value    $250,000   EBIT $25,000   Expansion-EBIT 20%   Recession-EBIT 35%   Debt issue $96,000   Interest rate 6%   Shares outstanding     6,000   Tax Rate

30%  

Explanation / Answer

1.EPS under each scenario:

2.percentage change:

working note:

consider recession: change in EPS =(recession EPS - normal EPS) / normal EPS

=> (1.90-2.92) / 2.92

=>-34.93%.

consider expansion : change in EPS = (expansion EPS - normal EPS) / normal EPS

=> (3.50-2.92) / 2.92

=>19.86%

recession normal expansion EPS 1.90 2.92 3.50

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