Question

Southern Wind is an all-equity firm with 24,100 shares of stock outstanding and a total market value of $370,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $35,000 if the economy is normal, $21,200 if the economy is in a recession, and $48,800 if the economy booms. Ignore taxes. Management is considering issuing $93,400 of debt with an interest rate of 8 percent. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy booms?

Multiple Choice

• $2.29

• $1.53

• $1.99

• $2.65

• $2.49

Answer 1

The EPS is computed as shown below:

Current value per share is computed as follows:

= Total market value / Number of shares outstanding

= $ 370,000 / 24,100

= $ 15.3526971

Number of shares after repurchase is computed as follows:

= Current number of shares - Debt proceeds / Current value per share

= 24,100 - $ 93,400 / $ 15.3526971

= 18,016.37838 shares

EPS will be computed as follows:

= (EBIT - Amount of debt x interest rate) / Number of shares after repurchase

= ($ 48,800 - $ 93,400 x 8%) / 18,016.37838 shares

= $ 41,328/ 18,016.37838 shares

= $ 2.29 Approximately

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