Pendergast, Inc., has no debt outstanding and a total market value of $200,000.
ID: 2787819 • Letter: P
Question
Pendergast, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergast is considering a $70,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Pendergast has a tax rate of 35 percent.
Pendergast, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergast is considering a $70,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Pendergast has a tax rate of 35 percent.
a-1 Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Round your answers to 2 decimal places. (e.g., 32.16) EPS Recession Normal Expansion a-2 Calculate the percentage changes in EPS when the economy expands or enters a recession (Negative amounts should be indicated by a minus sign.) Percentage changes in EPS Recession Expansion b-1 Assume that the company goes through with recapitalization. Calculate earnings per share (EPS) the three economic scenarios assuming the company goes through with recapitalization under each of (Round your 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. Round your answers to 2 decimal places. (e.g., 32.16)) Percentage changes in EPS Recession 1% ExpansionExplanation / Answer
As no interest is there
EBIT in all cases will become NI before tax
EBIT in recession = 24,000 * 0.7
EBIT in recession = 16,800
EPS = 16,800 * (1 - 0.35)/ 8,000
EPS = 1.37
EBIT in Normal = 24,000
EPS = 24,000 * 0.65/ 8,000
EPS = 1.95
EBIT in expansion = 24,000 * 1.15
EBIT in expansion = 27,600
EPS = 27,600/ 8,000
EPS = 2.24
% change in EPS when enter to recession = (1.37 - 1.95)/ 1.95
% change in EPS when enter to recession = -30%
% change in EPS when enter to expnasion = (2.24 - 1.95)/ 1.95
% change in EPS when enter to expansion = 15%
Part B
If the company undergoes the proposed recapitalization, it will repurchase
Share price = Equity / Shares outstanding
Share price = 200,000/ 8,000
Share price = 25
Share Repurchase = Debt Issued/ Share Price
Share Repurchase = 70,000/ 25
Share Repurchase = 2,800
Number of outstanding shares left = 8,000 - 2,800
Number of outstanding shares left = 5,200
Interest Payment = 70,000 * 0.07
Interest Payment = 4,900
New NI in all cases:
NI in recession = (24,000 * 0.70 - 4900) * 0.65
NI in recession = 7,735
EPS in reccesion = 7,735/ 5200
EPS in reccesion = 1.49
NI in normal = (24,000 - 4900) * 0.65
NI in normal = 12,415
EPS in normal = 12,415/ 5200
EPS in normal = 2.39
NI in Expansion = (24,000 * 1.15 - 4900) * 0.65
NI in Expansion = 14,755
EPS in expansion = 2.84
Part B - 2
% change in EPS when entered to recesion = (1.49/2.39) - 1
% change in EPS when entered to recesion = -37.70%
% change in EPS when entered to expansion = (2.84/2.39) - 1
% change in EPS when entered to expansion = 18.85%
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