Question

Music City, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $40,000 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 20 percent lower. The company is considering a $135,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. The company has a tax rate 35 percent. Assume the stock price is constant. |

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. |
Calculate earnings per share (EPS) under each of the three
economic scenarios assuming the company goes through with
recapitalization. |

EPS | ||

Recession | $ | |

Normal | $ | |

Expansion | $ | |

b-2. |
Given the recapitalization, calculate the percentage changes in
EPS when the economy expands or enters a recession. |

Percentage changes in EPS | ||

Recession | % | |

Expansion | % | |

Answer #1

Sunrise, Inc., has no debt outstanding and a total market value
of $220,000. Earnings before interest and taxes, EBIT, are
projected to be $42,000 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 30 percent
lower. The company is considering a $66,000 debt issue with an
interest rate of 6 percent. The proceeds will be used to repurchase
shares of...

Kaelea, Inc., has no debt outstanding and a total market value
of $75,000. Earnings before interest and taxes, EBIT, are projected
to be $9,400 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 24 percent higher. If
there is a recession, then EBIT will be 31 percent lower. The
company is considering a $22,500 debt issue with an interest rate
of 8 percent. The proceeds will be used to repurchase shares of...

Castle, Inc., has no
debt outstanding and a total market value of $200,000. Earnings
before interest and taxes, EBIT, are projected to be $24,000 if
economic conditions are normal. If there is strong expansion in the
economy, then EBIT will be 15 percent higher. If there is a
recession, then EBIT will be 30 percent lower. The firm is
considering a debt issue of $70,000 with an interest rate of 7
percent. The proceeds will be used to repurchase shares...

Castle, Inc., has no debt outstanding and a total market value
of $240,000. Earnings before interest and taxes, EBIT, are
projected to be $36,000 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 25 percent
lower. The firm is considering a debt issue of $155,000 with an
interest rate of 6 percent. The proceeds will be used to repurchase
shares...

Kaelea, Inc., has no debt outstanding and a total market value
of $57,000. Earnings before interest and taxes, EBIT, are projected
to be $8,200 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 22 percent higher. If
there is a recession, then EBIT will be 33 percent lower. Kaelea is
considering a $20,700 debt issue with an interest rate of 8
percent. The proceeds will be used to repurchase shares of stock....

Sunrise, Inc., has no debt outstanding and a total market value
of $250,000. Earnings before interest and taxes, EBIT, are
projected to be $19,000 if economic conditions are normal. If there
is strong expansion in the economy, then EBIT will be 18 percent
higher. If there is a recession, then EBIT will be 30 percent
lower. The company is considering a $100,000 debt issue with an
interest rate of 8 percent. The proceeds will be used to repurchase
shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$220,000. Earnings before interest and taxes, EBIT, are projected
to be $36,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 18 percent higher. If
there is a recession, then EBIT will be 25 percent lower. The
company is considering a $125,000 debt issue with an interest rate
of 8 percent. The proceeds will be used to repurchase shares of...

Money, Inc., has no debt outstanding and a total market value of
$220,000. Earnings before interest and taxes, EBIT, are projected
to be $42,000 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 30 percent lower. Money is
considering a $66,000 debt issue with an interest rate of 6
percent. The proceeds will be used to repurchase shares of stock....

Ghost, Inc., has no debt outstanding and a total market value of
$262,500. Earnings before interest and taxes, EBIT, are projected
to be $42,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 16 percent higher. If
there is a recession, then EBIT will be 27 percent lower. The
company is considering a $140,000 debt issue with an interest rate
of 5 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$220,100. Earnings before interest and taxes, EBIT, are projected
to be $38,000 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 23 percent lower. The
company is considering a $120,000 debt issue with an interest rate
of 5 percent. The proceeds will be used to repurchase shares of...

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