Question

Southern Wind is an all-equity firm with 23,300 shares of stock outstanding and a total market value of $368,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $34,000 if the economy is normal, $20,400 if the economy is in a recession, and $47,600 if the economy booms. Ignore taxes. Management is considering issuing $92,800 of debt with an interest rate of 6 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?

Answer 1

The EPS is computed as shown below:

Current value per share is computed as follows:

= Total market value / Number of shares outstanding

= $ 368,000 / 23,300

= $ 15.79399142

Number of shares after repurchase is computed as follows:

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

= 23,300 - $ 92,800 / $ 15.79399142

= 17,424.34783 shares

EPS will be computed as follows:

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

= ($ 47,600 - $ 92,800 x 6%) / 17,424.34783 shares

= $ 42,032 / 17,424.34783 shares

= $ 2.41 Approximately

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