Kaelea, Inc., has no debt outstanding and a total market value of $110,000. Earn

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Kaelea, Inc., has no debt outstanding and a total market value of $110,000. Earnings before interest and taxes, EBIT, are projected to be $8,800 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 $36,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,400 shares outstanding. Assume the company has a tax rate of 35 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 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.) 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 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.) Recession

Explanation / Answer

a. No Debt EBIT Less: Tax at 35% EAT EPS= EAT/4400 Recession 5984 2094.4 3889.6 0.88 Normal 8800 3080 5720 1.30 Expansion 10824 3788.4 7035.6 1.60 b. % change in EPS Recession (0.88-1.3)/1.3= -32.31% Expansion (1.6-1.3)/1.3= 23.08% No.of equity shares that can be repurchased with funds from debt proceeds=36000/25= 1440 No.of shares remaining for EPS calculations= 4400-1440 2960 C. With debt - interest 36000*6%= 2160 EBIT Less: Int.on debt EBT= EBIT-Int. Less: Tax at 35% EAT EPS= EAT/2960 Recession 5984 2160 3824 1338.4 2485.6 0.84 Normal 8800 2160 6640 2324 4316 1.46 Expansion 10824 2160 8664 3032.4 5631.6 1.90 d. % change in EPS Recession (0.84-1.46)/1.46= -42.47% Expansion (1.90-1.46)/1.46= 30.14%

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