Question

Kaelea, Inc., has no debt outstanding and a total market value of $165,000. Earnings before interest and taxes, EBIT, are projected to be $9,900 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 24 percent higher. If there is a recession, then EBIT will be 31 percent lower. The company is considering a $46,500 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding. Assume the company has a tax rate of 34 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	%

Answer 1

NORMAL EBIT=$9,900

EBIT @ recession=$9,900*(1-31%)=$9,900*0.69=$6,831

EBIT @expansion=$9,900*1.24=$12,276

CALCULATION OF EPS AND CHANGES IN EPS IF THERE IS NO DEBT
	RECESSION	NORMAL	EXPANSION
EBIT	$                               6,831.00	$   9,900.00	$                      12,276.00
INTEREST	$                                            -	$                -	$                                     -
EBT	$                               6,831.00	$   9,900.00	$                      12,276.00
TAX@34%	$                               2,322.54	$   3,366.00	$                        4,173.84
EAT(EBT-TAX)	$                               4,508.46	$   6,534.00	$                        8,102.16
NO OF SHARES	5,500	5,500	5,500
EPS(EAT/No of Shares)	$                                       0.82	$           1.19	$                                1.47
CHANGE IN EPS	-0.31%		0.24%

a.EPS is $0.82,$1.19 &$1.47 @recession,normal and expansion respectively

b.Change in EPS is -0.31% when economy enters recession and 0.24% when economy expands(same change as that of EBIT,when there is no debt)

CALCULATION OF EPS AND CHANGES IN EPS WHEN THERE IS DEBT OF $46,500
	RECESSION	NORMAL	EXPANSION
EBIT	$                               6,831.00	$   9,900.00	$                      12,276.00
INTEREST	$                               2,325.00	$   2,325.00	$                        2,325.00
EBT	$                               4,506.00	$   7,575.00	$                        9,951.00
TAX@34%	$                               1,532.04	$   2,575.50	$                        3,383.34
EAT(EBT-TAX)	$                               2,973.96	$   4,999.50	$                        6,567.66
NO OF SHARES	3,950	3,950	3,950
EPS(EAT/No of Shares)	$                                       0.75	$           1.27	$                                1.66
CHANGE IN EPS	-40.51%		31.37%

No of shares existing=5,500 with a total market value of $165,000

Value of single share=$165,000/5,500=$30

No. of shares that can be repurchase with loan of $46,500=$46,500/30=1550

No. of shares outstanding=5500-1550=3950

C.EPS IS $0.75(RECESSION),$1.27 (NORMAL) AND $1.66 When economy expands

d .Change in EPS is -40.51,when economy enters recession and 31.37% when economy expands