Question

Kaelea, Inc., has no debt outstanding and a total market value of $153,000. Earnings before interest and taxes, EBIT, are projected to be $9,500 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 35 percent lower. The company is considering a $45,300 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,100 shares outstanding. Ignore taxes for this problem.

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.)

	%ΔEPS
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.)

	%ΔEPS
Recession	%
Expansion	%

Answer 1

PT a EPS = Earnings available for shareholder/outstanding shares

Recession EPS =(9500*0.65)/5100 i.e.$1.21

Normal EPS =9500/5100 i.e.$1.86

Expansion EPS =(9500*1.2)/5100 i.e.$2.23

PT b

Change in EPs Recession = (1.21-1.86)/1.86 i.e. - 0.34946 i.e. -34.95%

Change in EPs Expansion = (2.23-1.86)/1.86 i.e. 0.1989 i.e.19.89%

PT c Price = Total Market value/outstanding shares

                  =153000/5100 i.e.$30

Interest =45300*5% i.e.2265

Share repurchase =45300/30 i.e.1510 shares

Outstanding shares =5100-1510 i.e. 3590 shares

EBT = EBIT – Interest

        =9500-2265 i.e.$7235

EPS = Earnings available for shareholder/outstanding shares

Recession EPS =(7235*0.65)/3590 i.e.$1.31

Normal EPS =7235/3590 i.e.$2.02

Expansion EPS =(7235*1.2)/3590 i.e.$2.42

PT d

Change in EPs Recession = (1.31-2.02)/2.02 i.e. - 0.35148 i.e. -35.15%

Change in EPs Expansion = (2.42-2.02)/2.02 i.e. 0.1980 i.e.19.80%