Question

Great Harvest Logistics Ltd is a fully-equity-funded company with a market value of $650 million and five million shares outstanding. The company’s CFO Lewis Taylor is forecasting three different scenarios for the economic condition. Under the normal scenarios (base case), the company’s Earnings Before Interest and Taxes (EBIT) is projected to be $13.9 million. If the economy is better than expected (bull case), its EBIT is expected to be 20% higher than the base case, while its EBI T is projected to be 30% lower than the base case if the economy is worse than expected (bear case). Ignore any tax factor.

a What is the earnings per share (EPS) under each of the three scenarios?

b To take advantage of the low interest rate environment, Lewis is considering a plan to issue $65 million debt at a 3% interest r ate to finance a share repurchase programme. Under this plan, what is the EPS in each of the three scenarios?

c Under the share repurchase programme, how will the change in EPS under the bull and bear cases compare with the original capital structure? Why?

Answer 1

		Base Case	Bull Cast	Bear Case
a)	EBIT	$       1,39,00,000	$      1,66,80,000	$       97,30,000
	Total capital	$    65,00,00,000	$    65,00,00,000	$ 65,00,00,000
	Equity	$    65,00,00,000	$    65,00,00,000	$ 65,00,00,000
	Debt	$                          -	$                         -	$                       -
	Interest	$                          -	$                         -	$                       -
	EBT	$       1,39,00,000	$      1,66,80,000	$       97,30,000
	Tax	$                          -	$                         -	$                       -
	NI	$       1,39,00,000	$      1,66,80,000	$       97,30,000
	Number of shares	$          50,00,000	$          50,00,000	$       50,00,000
	EPS [NI/# shares]	$                     2.78	$                     3.34	$                  1.95
	% Change in EPS		20.00%	-30.00%
b)		Base Case	Bull Cast	Bear Case
	EBIT	$       1,39,00,000	$      1,66,80,000	$       97,30,000
	Total capital	$    65,00,00,000	$    65,00,00,000	$ 65,00,00,000
	Equity	$    58,50,00,000	$    58,50,00,000	$ 58,50,00,000
	Debt	$       6,50,00,000	$      6,50,00,000	$    6,50,00,000
	Interest [65000000*3%]	$          19,50,000	$          19,50,000	$       19,50,000
	EBT	$       1,19,50,000	$      1,47,30,000	$       77,80,000
	Tax	$                          -	$                         -	$                       -
	NI	$       1,19,50,000	$      1,47,30,000	$       77,80,000
	Number of shares	$          45,00,000	$          45,00,000	$       45,00,000
	EPS [NI/# shares]	$                     2.66	$                     3.27	$                  1.73
	% Change in EPS		23.26%	-34.90%
	CALCULATION FOR NUMBER OF SHARES:
	MV per share = 650000000/5000000 =	$                130.00
	# shares repurchased = 65000000/130 =	500000
	# shares after repurchase = 5000000-500000 =	4500000
c]	The % changes in EPS after repurchase of shares is more when compared with the % changes in
	EPS before repurchase. The increase in rate of change is due to financial leverage as the
	repurchase is effected by taking in debt.