Money, Inc., has no debt outstanding and a total market value of $200,000. Earni

Question

Money, Inc., has no debt outstanding and a total market value of $200,000. 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 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. Money is considering a $65,000 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.

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 final answers to 2 decimal places. (e.g., 32.16))

Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)

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 final answers to 2 decimal places. (e.g., 32.16))

Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

Money, Inc., has no debt outstanding and a total market value of $200,000. 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 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. Money is considering a $65,000 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.

Explanation / Answer

The EBIT in normal condition =$26000

expansion =$26000+12%=26000*0.12=26000+3120=29120

recession =$26000-25%=26000*0.25=26000-6500=19500

EPS in normal condition= EBIT/No of shares held= 26000/10000=2.60

expansion = 29120/10000=2.91

recession = 19500/10000=1.95

% of EPS change = expansion = 2.91-2.60=0.31/2.60*100=11.92%

= recession = 2.60-1.95 =0.65/2.60/100=25%

when recapitalisation takes place with $ 65000 debt at 6% intrest

the intrest per year is 65000*6%=$ 3900

so the new EBIT will be

in normal condition =26000-3900=22100

in expansion =29120-3900=25220

in recession =19500-3900=15600

so after repurchasr of shares with $ 65000(debt realised amount) no shares would be 10000-3250(65000/20 )(200000/10000=20)=6750

so new EPS in normal condition=22100/6750=3.27

expansion =25220/6750= 3.74

recession =15600/6750=2.31

percetage change in EPS in expansion= 3.74-3.27= .47/3.27*100=14.37%

in recession=3.27-2.31=0.96/3.27*100=29.36%   

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