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Dilana Corporation., has no debt outstanding and a total capital of $600,000. Operating earnings (Earnings before interest and taxes, EBIT) are projected to be $30,000 if economic conditions are normal, $50,000 if conditions are good, and $0 if conditions are bad. Theeconomic conditions are expected to be good with probability of 25%, normal with probability of 50%, and bad with a probability of 25%. Dilana is considering a $120,000 debt issue with a 10% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 12,000 shares outstanding. Ignore taxes in this question.
Question (a) What is the current share price?
Question (b) Calculate earnings per share [EPS] under each of the three economic scenarios before any debt is issued. Also calculate the expected EPS.
Question (c) Calculate return on equity [ROE] under each of the three economic scenarios before any debt is issued. Also calculate the expected ROE.
Question d) Repeat part (b) assuming that Dilana goes through with recapitalization. What do you observe?
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