Money, Inc., has no debt outstanding and a total market value of $275,000. Earni

Question

Money, Inc., has no debt outstanding and a total market value of $275,000. Earnings before interest and taxes, EBIT, are projected to be $21,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 40 percent lower. Money is considering a $99,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Money has a tax rate of 35 percent.

a-1. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued:

EPS

Recession $

Normal $

Expansion $

a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession.

Percentage changes in EPS

Recession %

Expansion %

b-1. Assume that the company goes through with recapitalization. Calculate earnings per share (EPS) under each of the three economic scenarios.

EPS

Recession $

Normal $

Expansion $

b-2. 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))

Percentage changes in EPS

Recession %

Expansion %

Explanation / Answer

Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued.>>>

Normal EPS = $300,000 / 10,000 = $30
Expansion EPS = $30 x 1.3 = $39
Recession EPS = $30 x 0.4 = $12

<<<calculate the percentage changes in EPS when the economy expands or enters a recession.>>>

No calculation is needed since the answer was already given.

the percentage changes in EPS when the economy expands = + 30%

the percentage changes in EPS when the economy enters a recession = - 60%

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