EBIT and Leverage Money, Inc., has no debt outstanding and a total market value

Question

EBIT and Leverage 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. Ignore taxes for this problem.
a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession.
b. Repeat part (a) assuming that Money goes through with recapitalization. What do you observe?

Explanation / Answer

Due to change of capital mix into debt and Equity, EPS per share has improved.

Question a. Strong Expected Expansion Recession EBIT 21000 26250 12600 No of Shares Outstanding 5000 5000 5000 Earnings per share 4.2 5.25 2.52 % of change 25.00% -40.00% Question b. EBIT 21000 26250 12600 Interest @8% 7920 7920 7920 EBT 13,080.00     18,330.00       4,680.00 Market Value per share 55 55 55 No of Treasury Stock purchased 1800 1800 1800 No of Shares Outstanding (5000-1800) 1800 1800 1800 Earnings Per share             7.27             10.18                2.60 % of change 40.14% -64.22%

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