Problem 16-1 EBIT and Leverage Money, Inc., has no debt outstanding and a total
ID: 2613559 • Letter: P
Question
Problem 16-1 EBIT and Leverage
Money, Inc., has no debt outstanding and a total market value of $140,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 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 30 percent lower. Money is considering a $115,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,000 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 $140,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 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 30 percent lower. Money is considering a $115,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,000 shares outstanding. Ignore taxes for this problem.
Explanation / Answer
Money INC. EPS projections before debt issue Economic Condition Normal Expansion Recession EBIT $ 32,000 35,840 22,400 Shares outstanding Nos 7,000 7,000 7,000 EPS $/Share 4.57 5.12 3.20 % Change in EPS in different economic conditions 12.00% -30.00% Money INC. EPS projections after debt issue Economic Condition Normal Expansion Recession EBIT $ 32,000 35,840 22,400 Debt Issued $ 115,000 115,000 115,000 Interest $ @6% 6,900 6,900 6,900 EBT 25,100 28,940 15,500 Shares outstanding Nos (after repurchase of 5750 shares with debt proceeds of $115,000 @ $20 per share) 1,250 1,250 1,250 EPS $/Share 25.60 28.67 17.92 % Change in EPS in different economic conditions 12.00% -30.00%