Kaelea, Inc., has no debt outstanding and a total market value of $130,000. Earn
ID: 2619535 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $130,000. Earnings before interest and taxes, EBIT, are projected to be $9,600 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 21 percent higher. If there is a recession, then EBIT will be 34 percent lower The company is considering a $38,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,200 shares outstanding. Ignore taxes for this problem. a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Recession Normal Expansion b. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g., 32.)Explanation / Answer
A)
Under Normal Economic Conditions
EPS = EBIT/shares outstanding = $9,600/5,200 = $1.85
Under Expansionary Times: EPS = [EBIT x 1.21]/shares outstanding = $9,600(1.21)/5,200
= $11,616/2,500 = $2.23
Under a Recession:
EPS = [EBIT x (1-.34)]/shares outstanding
=$9,600(.66)/5,200
= $6336/5,200 = $1.22
B)
% ? EPS going from Normal – Expansion =
= ( 2.23 – 1.85) / 1.85
=0.2054 or 20.54%
% ? EPS going from Normal - Recession:
= ( 1.22 – 1.85)/1.85
= -0.3405 or -34.05
C)
If the market value of the firm is $130,000 with 5,200 shares outstanding, then the value of one share of stock is: $130,000/5,200 = $25/share.
If $38,000 worth of debt is raised to retire stock, then you will be buying back $38,000/$25 or 1,520 shares. So, after recapitalization there will be 5,200 -1,520 or 3,680 shares outstanding
EBIT will be reduced by the amount of the interest on $38,000 in debt or $38,000 x .06 = $2,280
Normal Conditions:
EPS = $7,320/3680 = $1.99
Expansionary Times:
EPS = $9336/3680 = $2.54
d)
% ? EPS going from Normal to Expansion:
= ( 2.54- 1.99) / 1.99
= 0.2764 or 27.64%
% ? EPS going from Normal to Recession:
= ( 1.1 – 1.99 ) / 1.99
= -0.4459 or 44.59 %
Recession Normal Expansion EBIT 6336 9600 11616 Less- Interest 2280 2280 2280 EBT = NI 4056 7320 9336 EPS 1.10 1.99 2.54Related Questions
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