Kaelea, Inc., has no debt outstanding and a total market value of $165,000. Earn
ID: 2715947 • Letter: K
Question
Kaelea, 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. Kaelea 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).) Assume Kaelea goes through with recapitalization. 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).)Explanation / Answer
EBIT when expansion = 9900 * (1+24%) = 12276
EBIT when recession = 9800 * (1-31%) = 6831
Requirement 1 is mentioned and calculated in the below table
Here Interest is 0 since there is no debt, tax rate is taken as 0%, EPS = net income / no. of shares, and no. of shares is given as 5500
Requirement 2:
In requirement 2, a new debt is issued for $46,500
Interest paid per year would be 46500 * 5% = 2325
This raised capital is used to purchase shares, so we have to calculate how many shares are bought by the company.
Current share price = 165000 / 5500 = $30
No. of shares bought = 46500 / 30 = 1550 shares
No of shares outstanding after share buyback = 5500 - 1550 = 3950
Now again the above table is modified with these values as follows
Economy EBIT Interest PBT Tax Net Income EPS Change Normal 9,900.00 0 9,900.00 0 9,900.00 1.80 Expansion 12,276.00 0 12,276.00 0 12,276.00 2.23 24.00% Recession 6,831.00 0 6,831.00 0 6,831.00 1.24 -31.00%Related Questions
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