Kaelea, Inc., has no debt outstanding and a total market value of $57,000. Earni
ID: 2753008 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $57,000. Earnings before interest and taxes, EBIT, are projected to be $8,200 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 33 percent lower. Kaelea is considering a $20,700 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 3,800 shares outstanding. Ignore taxes for this problem se shares of stock. There are currenty 3,800 shares outstanding. lgnore taxes for Requirement 1: (a) 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).) 9 Recession Normal Expansion (b) 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).) Recession Expansion Requirement 2:Explanation / Answer
Calculation of EPS of Kaelea Inc., under Various circumstances
EBIT in case of Normal economy: $8,200
EBIT in case of economic expansion it will be higher by 22%= $8,200 + 22% = $10,004
EBIT in case of recesion it will be lower by 33% = $8,200 - 33% = $5,494
1 A: Calculation of EPS
EPS =
EBIT / No. of Shares
1 B: Calculation of % Change in EPS
Change in EPS
(EPS - Normal EPS)
% Change in EPS
(Change in EPS / Normal EPS)
Recapitalisation Workings:
Total Market value of Kaelea = $57,000
No. of Shares outstanding = 3,800
Therefore Market Price per Share = $57,000 / 3,800 = $15 per share
Debt issue size = $20,700 @ 8%
Therefore No. of Share that can be repurchased
= Debt Issue Size / Market Value of Each Share
= $20,700 / $15
= 1,380 Share
Outstanding Shares after Repurchase = 3,800 - 1,380 = 2,420 Shares
Interest Payment on Bonds p.a. = $20,700 X 8% = $1,656 ( EBIT will be reduce to the extent of Interest on Bonds)
2 A: Calculation of EPS after Repurchase
EBIT after
Repurchase
EPS =
EBIT / No. of Shares
2 B: Calculation of % Change in EPS after Repurcse
Change in EPS
(EPS - Normal EPS)
% Change in EPS
(Change in EPS / Normal EPS)
State of Economy EBIT Shares OutstandingEPS =
EBIT / No. of Shares
Normal 8,200 3,800 2.16 Expansion 10,004 3,800 2.63 Recession 5,494 3,800 1.45Related Questions
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