Music City, Inc., has no debt outstanding and a total market value of $220,000.
ID: 2566326 • Letter: M
Question
Music City, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 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 25 percent lower. The company is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. The company has a tax rate 35 percent. Assume the stock price is constant.
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.)
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 the nearest whole number, e.g., 32.)
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.)
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.)
Music City, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 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 25 percent lower. The company is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. The company has a tax rate 35 percent. Assume the stock price is constant.
Explanation / Answer
A1
A2 Recession = (1.60-2.13)/ 2.13 = 25%
Expansion = (2.51-2.13)/2.13 = 18%
B1 If debt is issued of 125,000 and shares are repurchased , new market value = 220,000-125,000 = 95000
Share price = 220000/11000 = 20
Therefore no of shares remaining = 95000/20 = 4750 shares
Interest = 125000X8% = 10000
25% (B2)
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Recession Normal Expansion EBIT 27,000 36,000 42,480 Interest 0 0 0 Taxes 9,450 12,600 14,868 Net Income 17,550 23,400 27,612 No of shares 11,000 11,000 11,000 EPS 1.60 2.13 2.51Related Questions
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