Question

Blackstone Corp is considering a change in its capital structure. Currently, it is an all-equity firm with 25,300 shares of stock outstanding and a total market value of $373,000. Based on its current capital structure,

the firm is expected to have earnings before interest and taxes of $36,500 if the economy is normal, $22,400 if the economy is in a recession, and $50,600 if the economy booms. Ignore taxes. The management
is considering issuing $94,300 of debt with an interest rate of 7 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?

A. $2.03
B. $2.69
C. $2.33
D. $1.58
E. $2.52

Answer 1

Blackstone Corp's earnings per share (EPS) if it issues debt and the economy booms will be C. $2.33. This is calculated by deducting interest on the new debt from the boomed economy earnings.

Step-by-step explanation:

The question asks about the effect of a change in capital structure on the earnings per share (EPS) for Blackstone Corp if the economy booms. The company is currently all-equity and is considering the introduction of debt to repurchase some of its stock. To calculate the new EPS, we first compute the earnings after interest by subtracting the annual interest on the new debt from the boomed economy earnings. Then, we calculate the new number of shares outstanding after the stock repurchase with the proceeds of the debt. Finally, the EPS is found by dividing the new earnings by the new number of shares outstanding.

Here's the step-by-step calculation:

1. Earnings before interest and taxes (EBIT) if the economy booms: $50,600.
2. Annual interest on new debt at 7% of $94,300: 0.07 × $94,300 = $6,601.
3. Earnings after interest: $50,600 - $6,601 = $43,999.
4. Amount of shares repurchased: $94,300/Current share price ($373,000/25,300 shares) = $94,300/$14.74 per share ≈ 6399 shares.
5. New number of shares outstanding: 25,300 shares - 6399 shares = 18,901 shares.
6. EPS if debt is issued and economy booms: $43,999 / 18,901 shares ≈ $2.33.

Therefore, if Blackstone Corp issues the debt and the economy booms, the earnings per share (EPS) will be $2.33.