Kaelea, Inc., has no debt outstanding and a total market value of $98,000. Earni
ID: 2788669 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $98,000. Earnings before interest and taxes, EBIT, are projected to be $9,300 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 23 percent higher. If there is a recession, then EBIT will be 32 percent lower. The company is considering a $29,800 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,900 shares outstanding. Assume the company has a tax rate of 30 percent. a. 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 answers to 2 decimal places, e.g., 32.16.) EPS Recession $ Normal $ Expansion $ b. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g., 32.) %EPS Recession % Expansion % Assume the company goes through with recapitalization. c. Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Recession $ Normal $ Expansion $ d. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) %EPS Recession % Expansion %
Explanation / Answer
Without debt, Profits = EBIT x (1 - tax rate)
EPS = Profits / No. of shares
Initially, No. of shares = 4,900
Stock Price = 98,000 / 4,900 = $20
After the debt issue, the no. of shares repurchased = 29,800 / 20 = 1,490
New outstanding shares = 4,900 - 1,490 = 3,410
After the debt issue, Profits = (EBIT - Interest) x (1 - tax rate)
Interest = 29,800 x 7% = $2,086
Kaelea Recession Normal Expansion EBIT 6324 9300 11439 Tax (30%) 1897.2 2790 3431.7 Profits 4426.8 6510 8007.3 EPS $ 1.29 $ 1.90 $ 2.33 % Change -32.00% 23.00% With Debt EBIT 6324 9300 11439 Interest 2086 2086 2086 EBT 4238 7214 9353 Tax (30%) 1271.4 2164.2 2805.9 Profits 2966.6 5049.8 6547.1 EPS $ 0.87 $ 1.48 $ 1.92 % Change -41.25% 29.65%Related Questions
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