Question

Minion, 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 10 percent higher. If there is a recession, then EBIT will be 25 percent lower. The company is considering a $48,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 20,000 shares outstanding. Ignore taxes for this problem.

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 2 decimal places, e.g., 32.16.)
b-1.	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.)
b-2.	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.)

Answer 1

a
	Recession	Normal	Expansion
EBIT	21,000	28,000	30,800
Less: Interest	0	0	0
Earnings before taxes	21,000	28,000	30,800
Less: Taxes	0	0	0
Net Income	21,000	28,000	30,800
Number of Shares	20,000	20,000	20,000
EPS	1.05	1.40	1.54
% change
Recession	-25.00%
Expansion	10.00%

b
	Recession	Normal	Expansion
EBIT	21,000	28,000	30,800
Less: Interest	1920	1920	1920
Earnings before taxes	19,080	26,080	28,880
Less: Taxes	0	0	0
Net Income	19,080	26,080	28,880
Number of Shares	16,000	16,000	16,000
EPS	1.19	1.63	1.81
% change
Recession	-26.84%
Expansion	10.74%