Dell Ltd has no debt outstanding, and currently has a market value of $125 million. There are three possible scenarios for the next year:

Economic condition Earnings before interest and tax (EBIT)
Strong $15 million
Normal $10 million
Weak $5 million

 

The company is considering issuing $50m of debt with 5% interest rate. Dell will use the money raised through the debt issuance to repurchase the ordinary shares. There are currently 10 million shares outstanding.

  1. Assume no tax, what are the possible outcomes for earnings per share (EPS) next year before the debt is issued?
  2. Assume Dell has issued the debt and repurchased the shares, calculate (a) again. What do you observe?

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