ACCOUNTING
Case 55.docx

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4. In light of your previous answers, the information in Exhibit 3, and information in the case, evaluate the argument that Meredith is underlevered at the present time (1995). We believe that Meredith Corporation is underlevered for a few reasons. These include;

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A. D/E (Debt/Equity) ratio is 0.22 versus an industry average of 0.38. This means that the average corporation in the same industry as Meredith uses debt for 38% of their financing while Meredith uses just 22%. If Meredith wants to increase their debt they must ensure that they can adequately cover new debt expense. B. On the normalized income statement interest expense is just 0.61% of Meredith’s sales while the industry average is 1.04%. Meredith appears underlevered compared to industry averages in this context. C. TIE (times Interest Earned) is 9.84 with Meredith compared to 7.88 with average companies in this industry. As we recall the TIE ratio is a company’s ability to service its debt. Meredith’s ratio of 9.84 is higher than the industry average. This means that Meredith should be able to service their debts more easily when compared to other companies in their industry. D. When we compare Meredith’s DOL, DFL and DTL to those of other companies in that industry we see that Meredith’s ratios are in line with Industry Averages. We calculated a DOL of 3.83 compared to an industry average of 3.66, a DFL of 1.13 compared to the industry average of 1.15, and a DTL of 4.26 compared to an industry average of 4.19. While these figures are a good way to measure leverage, in this case these figures provide little to no evidence that Meredith is underlevered. 5. Complete the table in Exhibit 7. (Assume a dividend of \$0.50 per share on any new stock.) Yearly Cash Outlays (Before Taxes) of Each financing Option (\$MIllions) Bond Option stock option combination Year Int. SF Div. Int. SF Div. Int. SF Div. 1996 \$5 \$2.5 0 0 0 \$1 \$2.5 1.25 \$.50 1997 \$5 \$2.5 0 0 0 \$1 \$2.5 1.25 \$.50 6. What is Meredith's 1996 and 1997 estimated earnings per share (EPS) if it uses the bond option? The stock option? The 1996 and 1997 EPS estimates are \$1.88 and \$2.71, respectively, if the combination option is used. Stock Option By using 1995 numbers we calculated that there were 8.2 million shares outstanding. We took the Net Income of 16.17 million and divided that by the EPS of 1.97 a share to find the shares outstanding. With the need to raise 50 million in funds we calculated the amount of new shares needed to be 2 million. With the addition of 2 million shares it was calculated that the EPS in 1996 and 1997 would be \$1.84 and \$2.59 respectively. This is with all of the funding coming from the issuance of new shares of stock.
Bond Option With the bond option we calculated that the 50 million in funding would incur additional interest charges of 5 million each year. With the new bond issuance I calculated the EPS to be \$ 1.92 and \$2.85 per share in 1996 and 1997 respectfully. The number of outstanding shares of stock remains at 8.2 million in this case.

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