Question

Minion, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $150,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 15,000 shares outstanding. Ignore taxes for this problem -1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g.. 32.16.) b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization(Do not round intermediate calculations and round your answers to 2 decimal places, e.g.. 32.16.) b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g. 32.16.) a-1. Recession EPS Normal EPS Expansion EPS

Answer 1

Normal:

EBIT = $26,000

Recession:

EBIT = $26,000 - 20% * $26,000
EBIT = $20,800

Expansion:

EBIT = $26,000 + 18% * $26,000
EBIT = $30,680

Answer a-1.

Total Value = $240,000
Number of shares outstanding = 15,000

Price per share = Total Value / Number of shares outstanding
Price per share = $240,000 / 15,000
Price per share = $16.00

Recession 20,800 $ Normal Expansion 26,000$ 30,680 20,800 $ 26,000 $ 30,680 Less: Interest Expense EBT Less: Taxes Net Income # of Shares EPS $ $ 26.000 20 680 20,800 $ 15,000 1.39 $ 15,000 1.73 $ 15,000 2.05

Answer a-2.

If economy expand:

Percentage Change in EPS = ($2.05 - $1.73) / $1.73
Percentage Change in EPS = 18.50%

If economy collapse:

Percentage Change in EPS = ($1.39 - $1.73) / $1.73
Percentage Change in EPS = -19.65%

Answer b-1.

Value of Debt = $150,000

Interest Expense = 8% * $150,000
Interest Expense = $12,000

Value of Equity = $90,000
Price per share = $16.00

Number of shares outstanding = $90,000 / $16.00
Number of shares outstanding = 5,625

Recession 20,800 $ 12,000 $ 8,800 $ Normal 26,000 12,000 14,000 Expansion $ 30,680 $ 12,000 $ 18,680 EBIT Less: Interest Expense EBT Less: Taxes Net Income # of Shares sles es $ 8,800 5,625 1.56 14,000 5,625 2.49 18,680 5,625 3.32 EPS es $ $

Answer b-2.

If economy expand:

Percentage Change in EPS = ($3.32 - $2.49) / $2.49
Percentage Change in EPS = 33.33%

If economy collapse:

Percentage Change in EPS = ($1.56 - $2.49) / $2.49
Percentage Change in EPS = -37.35%