Beckett, Inc., has no debt outstanding and a total market value of $240,000. Ear

Question

Beckett, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. Beckett is considering a debt issue of $150,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 15,000 shares outstanding. The company has a tax rate 35 percent.

Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.

Calculate the percentage changes in EPS when the economy expands or enters a recession.

Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.

Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.

Beckett, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. Beckett is considering a debt issue of $150,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 15,000 shares outstanding. The company has a tax rate 35 percent.

Explanation / Answer

Normal Recession Expansion EBIT 26000 20800 30680 Tax 9100 7280 10738 PAT 16900 13520 19942 Shares Outstanding 15000 15000 15000 EPS 1.13 0.90 1.33 % Change -20.00% 18.00% Share price 240000/15000 16 Shares Repurchased 9375 Shares left 5625 Normal Recession Expansion EBIT 26000 20800 30680 Interest 12000 12000 12000 EBIT-Interest 14000 8800 18680 Tax 4900 3080 6538 PAT 9100 5720 12142 Shares Outstanding 5625 5625 5625 EPS 1.62 1.02 2.16 % Change -37.14% 33.43%

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