Question

Pendergast, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergast is considering a $75,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. Ignore taxes for this problem.

Answer all of the following:

A-1 Calculate the earning 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.)

Percentages changes in EPS
Recession	%
Expansion	%

B-1 Assume that the company goes through with recapitalization. Calculate earnings per share (EPS ) under each of the three economic scenarios assuming the company goes through with the recapitalization.

	EPS
Recession	$
Normal	$
Expansion	$

B-2 Given the recapitalization calculate the percentage changes in EPS when the economy expands of enters a recession.

Percentage changes in EPS
Recession	$
Expansion	$

Answer 1