Question

Minion, Inc., has no debt outstanding and a total market value of $211,875. Earnings before interest and taxes, EBIT, are projected to be $14,300 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. The company is considering a $33,900 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,500 shares outstanding. Assume the company has a tax rate of 21 percent.

a-1.	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.)
a-2.	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.)
b-1.	Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
b-2.	Calculate the percentage changes in EPS when the economy expands or enters a recession assuming recapitalization has occurred. (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.)

Answer 1

Normal:

EBIT = $14,300

Recession:

EBIT = $14,300 - 35% * $14,300
EBIT = $9,295

Expansion:

EBIT = $14,300 + 20% * $14,300
EBIT = $17,160

Answer a-1.

Total Value = $211,875
Number of shares outstanding = 7,500

Price per share = Total Value / Number of shares outstanding
Price per share = $211,875 / 7,500
Price per share = $28.25

Answer a-2.

If economy expand:

Percentage Change in EPS = ($1.81 - $1.51) / $1.51
Percentage Change in EPS = 20%

If economy collapse:

Percentage Change in EPS = ($0.98 - $1.51) / $1.51
Percentage Change in EPS = -35%

Answer b-1.

Value of Debt = $33,900

Interest Expense = 6% * $33,900
Interest Expense = $2,034

Value of Equity = $177,975
Price per share = $28.25

Number of shares outstanding = $177,975 / $28.25
Number of shares outstanding = 6,300

Answer b-2.

If economy expand:

Percentage Change in EPS = ($1.90 - $1.54) / $1.54
Percentage Change in EPS = 23.38%

If economy collapse:

Percentage Change in EPS = ($0.91 - $1.54) / $1.54
Percentage Change in EPS = -40.91%