Music City, Inc., has no debt outstanding and a total market value of $240,000.
ID: 2614365 • Letter: M
Question
Music City, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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. The company is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 12,000 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 $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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. The company is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 12,000 shares outstanding. The company has a tax rate 35 percent. Assume the stock price is constant.
Explanation / Answer
a-1 Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.
a-2 Calculate the percentage changes in EPS when the economy expands or enters a recession
Explanation of above
The EPS is the net income divided by 12000 of share outstanding
b-1 Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization
b-2 Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession
Explanation for part b
if company goes for expansion .
Share price = Equity / shares outstanding
=$ 240000/12000
=$ 20
shares repurchased = Debt issued / share price
= $140000/20
= 7000
Interest for each year = 140000*.06 = $8400
Explanation of above
The EPS is the net income divided by 12000 of share outstanding
EPS Recesson 1.13 normal 1.52 Expansion 1.70Related Questions
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