Beckett, Inc., has no debt outstanding and a total market value of $150,000. Ear
ID: 2734596 • Letter: B
Question
Beckett, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 10 percent higher. If there is a recession, then EBIT will be 30 percent lower. Beckett is considering a debt issue of $75,000 with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. The company has a tax rate 35 percent.
a-1.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 final answers to 2 decimal places (e.g., 32.16).) EPS Recession Normal Expansion 1.52 1.14 1.70 a-2.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. Enter your answers as a percent.) Percentage changes in EPS Recession Expansion b-1.Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).) EPS Recession Normal Expansion b-2.Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).) Percentage changes in EPS Recession ExpansionExplanation / Answer
Answer ( a-1):
Under Normal Economic Conditions
EPS = (EBIT-TAX)/Shares Outstanding
=(32000(1 - 0.35)) /10000
=20800/10000
=2.08
Under Recession times
EPS= (EBIT*(1 - 0.30) -TAX)/Shares Outstanding
= (32000*(1 -0.30) - (1-0.35)/10000
=14560/10000
=1.45
Under Expansion times
EPS= (EBIT*1.10 -TAX)/Shares Outstanding
= (32000*1.10 - (1-0.35)/10000
=22880/10000
=2.29
Answer (a-2):
% Change in EPS from Normal to Recession
=(1.45-2.08)/2.08 *100
= - 30.29%
% Change in EPS from Normal to Expansion = (2.29-2.08)/2.08 *100
=10.09%
Answer (b-1)
Market price per share = 150000/10000
=15
Total debt to be issued= 75000
No. of shares repurchased = 75000/15
= 5000
Outstanding shares after repurchase = 10000 - 5000
= 5000
Normal Recession Expansion
EBIT 32000 22400 35200
Less- Interest 4500 4500 4500
EBT 27500 17900 30700
Less- Tax 9625 6265 10745
Earning for shares 17875 11635 19955
Shares outstanding 5000 5000 5000
EPS 3.57 2.33 3.99
Answer (b-2)
% Change in EPS from Normal to Recession
=(2.33 - 3.57)/3.57 *100
= - 34.73%
% Change in EPS from Normal to Expansion = (3.99 - 3.57)/3.57 *100
=11.76%
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