Question

Minion, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $42,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $66,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem. a-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.

Answer 1

Normal:

EBIT = $42,000

Recession:

EBIT = $42,000 - 30% * $42,000
EBIT = $29,400

Expansion:

EBIT = $42,000 + 20% * $42,000
EBIT = $50,400

Answer a-1.

Total Value = $220,000
Number of shares outstanding = 10,000

Price per share = Total Value / Number of shares outstanding
Price per share = $220,000 / 10,000
Price per share = $22.00

Normal Recession Expansion |ЕВT Less: Interest |ЕВT Less: Taxes Net Income #of shares EPS 29,400 $ 42,000 $ 50400 29,400 $ $ $ 42,000 $ $ 42,000 $ 50400 29,400 $ 50400 10,000 10,000 10,000 4.20 $ 2.94 $ 5.04

Answer a-2.

If economy expand:

Percentage Change in EPS = ($5.04 - $4.20) / $4.20
Percentage Change in EPS = 20.00%

If economy collapse:

Percentage Change in EPS = ($2.94 - $4.20) / $4.20
Percentage Change in EPS = -30.00%

Answer b-1.

Value of Debt = $66,000

Interest Expense = 6% * $66,000
Interest Expense = $3,960

Value of Equity = $154,000
Price per share = $22.00

Number of shares outstanding = $154,000 / $22.00
Number of shares outstanding = 7,000

Normal Expansion Recession 29,400 $ $ 42,000 $ 3,960 $ 38,040 $ $ ЕВT 50400 3,960 $ 25,440 $ $ Less: Interest 3,960 ЕВT 46440 Less: Taxes Net Income #of shares EPS 25,440 $ 38,040 $ 46,440 7,000 7,000 7,000 5.43 $ 3.63 $ 6.63

Answer b-2.

If economy expand:

Percentage Change in EPS = ($6.63 - $5.43) / $5.43
Percentage Change in EPS = 22.10%

If economy collapse:

Percentage Change in EPS = ($3.63 - $5.43) / $5.43
Percentage Change in EPS = -33.15%