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. Pendergast has a tax rate of 35 percent.

  

a-1

Calculate earnings 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.)

  

Percentage 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 recapitalization. (Round your answers to 2 decimal places. (e.g., 32.16))

  

EPS
  Recession $   
  Normal $   
  Expansion $   

  

b-2

Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

  

Percentage changes in EPS
  Recession %
  Expansion %

Answer 1

A-1 & A-2 answars are shown in below table. in case of 100 % equity firm, number of outstanding shares are 6000.

No Levered
	Normal	Recssion	Expansion
EBIT	23000	16100	27600
Interest	0	0	0
EBT	23000	16100	27600
Tax@35%	8050	5635	9660
Net Profit	14950	10465	17940
No fo Shares	6000	6000	6000
EPS	2.49	1.74	2.99
Change in EPS		-30.00%	20%

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B1-B2 ( Hen 75000 are baught and proceed used to buyback shares, hence, new value of equity will be 105000.

Currently share price / share = 180000/6000 = 30.

Hence, new number of shares = 105000 / 30 = 3500

Interest of 75000 @ 7 % = 17750

Capitalized by debt
	Normal	Recssion	Expansion
EBIT	23000	16100	27600
Interest ( 7% for 75000)	5250	5250	5250
EBT	17750	10850	22350
Tax@35%	6212.5	3797.5	7822.5
Net Profit	11537.5	7052.5	14527.5
No fo Shares	3500	3500	3500
EPS	3.30	2.02	4.15
Change in EPS		-38.87%	26%