Question

Northern Wood Products is an all-equity firm with 17,100 shares of stock outstanding and a total market value of $356,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $28,000 if the economy is normal, $15,600 if the economy is in a recession, and $40,400 if the economy booms. Ignore taxes. Management is considering issuing $89,200 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 is in a recession?

Answer 1

The earnings per share for Northern Wood Products if it issues debt and repurchases stock during a recession would be approximately $0.80, after calculating the interest on the new debt, the net earnings, the number of shares repurchased, and dividing the net earnings by the new number of outstanding shares.

Step-by-step explanation:

To calculate the earnings per share (EPS) if Northern Wood Products issues debt and repurchases stock during a recession, we follow these steps:

1. Calculate the annual interest on the new debt: $89,200 at 6% interest rate equals $5,352.
2. Subtract the interest from the recession earnings before interest and taxes (EBIT) to get the net earnings: $15,600 - $5,352 = $10,248.
3. Determine the number of shares repurchased with the debt proceeds: Since the total market value is $356,000 and $89,200 debt is issued, the repurchase price per share is the same as the market value per share, which is $356,000/17,100 shares = $20.82 per share. Therefore, the company can repurchase $89,200 / $20.82 per share = approximately 4,285 shares.
4. Calculate the new number of outstanding shares: 17,100 shares - 4,285 shares repurchased = approximately 12,815 shares remaining.
5. Divide the net earnings by the new number of outstanding shares to get EPS: $10,248 / 12,815 shares = approximately $0.80 per share.

The earnings per share if the company issues the debt and the economy is in a recession would be approximately $0.80.