Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earn
ID: 2384414 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. Kaelea is considering a $42,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,250 shares outstanding. Assume Kaelea has a tax rate of 35 percent.
Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)
Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)
Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. Kaelea is considering a $42,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,250 shares outstanding. Assume Kaelea has a tax rate of 35 percent.
Explanation / Answer
Requirement 1:
(a)
Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Net Income in Normal Scenario = 10400 *(1-35%) = 6760
Net Income in recession Scenario = 10400*(1-35%) *(1-35%) = 4394
Net Income in Expansion Scenario = 10400*(1+20%) *(1-35%) = 8112
EPS in recession Scenario = Net Income in recession Scenario /outstanding Share
EPS in recession Scenario = 4394/6250
EPS in recession Scenario = 0.70
EPS in Normal Scenario = Net Income in Normal Scenario /outstanding Share
EPS in Normal Scenario = 6760/6250
EPS in Normal Scenario = 1.08
EPS inExpansion Scenario = Net Income in Expansion Scenario /outstanding Share
EPS in Expansion Scenario = 8112/6250
EPS in Expansion Scenario = 1.30
Answer
EPS
Recession $ 0.70
Normal $ 1.08
Expansion $ 1.30
(b)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)
EPS
Recession -35%
Expansion 20%
Requirement 2:
Assume Kaelea goes through with recapitalization.
(a)Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
Net Income in Normal Scenario = (10400-42000*6% )*(1-35%) = 5122
Net Income in recession Scenario = (10400*(1-35%)-42000*6% ) *(1-35%) = 2756
Net Income in Expansion Scenario = (10400*(1+20%)-42000*6% ) *(1-35%) = 6474
Market price per share = 125000/6250 = 20
No of Outstanding Share = 6250 - 42000/20 = 4150
EPS in recession Scenario = Net Income in recession Scenario /outstanding Share
EPS in recession Scenario = 2756/4150
EPS in recession Scenario = 0.66
EPS in Normal Scenario = Net Income in Normal Scenario /outstanding Share
EPS in Normal Scenario =5122/4150
EPS in Normal Scenario = 1.23
EPS inExpansion Scenario = Net Income in Expansion Scenario /outstanding Share
EPS in Expansion Scenario = 6474/4150
EPS in Expansion Scenario = 1.56
EPS
Recession $ 0.66
Normal $ 1.23
Expansion $ 1.56
(b)Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)
percentage changes in EPS when the economy expands = (1.56-1.234)/1.234
percentage changes in EPS when the economy expands = 26.40%
percentage changes in EPS when the economy recession = (0.664-1.234)/1.234
percentage changes in EPS when the economy recession = -46.19%
Answer
EPS
Recession -46.19%
Expansion 26.40%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.