Pendergast, Inc., has no debt outstanding and a total market value of $165,000.

Question

Pendergast, Inc., has no debt outstanding and a total market value of $165,000. Earnings before interest and taxes, EBIT, are projected to be $9,900 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 24 percent higher. If there is a recession, then EBIT will be 31 percent lower. Pendergast is considering a $46,500 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding. Ignore taxes for this problem.

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.Round your answers to 2 decimal places (e.g., 32.16).)

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.(Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

rev: 11_12_2013_QC_40178

Pendergast, Inc., has no debt outstanding and a total market value of $165,000. Earnings before interest and taxes, EBIT, are projected to be $9,900 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 24 percent higher. If there is a recession, then EBIT will be 31 percent lower. Pendergast is considering a $46,500 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding. Ignore taxes for this problem.

Explanation / Answer

a) recession

EBIT = $9900*(1-.31) = $6831

EPS = 6831/5500 = $1.242

Normal

EPS = 9900/5500 = 1.8

Expansion

EPS = 9900*1.24/5500 = 2.232

b)

Price of 1 share = 165000/5500 = $30

No of shares can be purchased in debt amount = 46500/30 = 1550

no of shares left outstanding = 5500-1550 = 3950

interest per annum to be paid = .05*46500 = $2325

now,

after recapitalization

recession

EPS = (6381-2325)/3950 = $1.02

Normal

EPS = (9900-2325)/3950 = $1.91

Expansion

EPS = (9900*1.24-2325)/3950 = $2.51

c)

since it is not clear in question whether we have to calculate % change in EPS after recapitalization of not

i am calculation %change in both ways

after capitalization

recession

% change in EPS = (1.02-1.91)/1.91 = -46.60%

expansion

% change in EPS = (2.51-1.91)/1.91 = 31.41%

before recapitalization

recession

% change in EPS = (1.24-1.8)/1.8 = -31.11%

expansion

% change in EPS = (2.23-1.8)/1.8 = 23.89%

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