Q1) Jagdambay Exports has no debt outstanding and a total market value of $180,0
ID: 1175024 • Letter: Q
Question
Q1) Jagdambay Exports 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% higher. If there is a recession, then EBIT will be 30% lower. Jagdambay Exports is considering a $75,000 debt issue with a 7% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. The tax rate is 35%. Based on the given information, please answer questions a and b. (10 Points)
a) Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession. (5 Points)
b) Repeat part (a) assuming that the company goes through with recapitalization. What do you observe? (5 Points)
Explanation / Answer
Normal
Expansionary
recessionary
EBIT
23000
27140
16100
less interest
0
0
0
EBT
23000
27140
16100
tax-35%
8050
9499
5635
after tax profit
14950
17641
10465
no of shares
6000
6000
6000
EPS
after tax profit/no of shares
2.491667
2.940167
1.744167
% change in EPS
change in EPS / EPS at normal
18%
-30%
Normal
Expansionary
recessionary
EBIT
23000
27140
16100
less interest
5250
5250
5250
EBT
17750
21890
10850
tax-35%
6212.5
7661.5
3797.5
after tax profit
11537.5
14228.5
7052.5
no of shares
(180000-75000)/30 = 180000/60 = 30
3500
3500
3500
EPS
after tax profit/no of shares
3.296429
4.065286
2.015
% change in EPS
change in EPS / EPS at normal
23%
-39%
Normal
Expansionary
recessionary
EBIT
23000
27140
16100
less interest
0
0
0
EBT
23000
27140
16100
tax-35%
8050
9499
5635
after tax profit
14950
17641
10465
no of shares
6000
6000
6000
EPS
after tax profit/no of shares
2.491667
2.940167
1.744167
% change in EPS
change in EPS / EPS at normal
18%
-30%
Normal
Expansionary
recessionary
EBIT
23000
27140
16100
less interest
5250
5250
5250
EBT
17750
21890
10850
tax-35%
6212.5
7661.5
3797.5
after tax profit
11537.5
14228.5
7052.5
no of shares
(180000-75000)/30 = 180000/60 = 30
3500
3500
3500
EPS
after tax profit/no of shares
3.296429
4.065286
2.015
% change in EPS
change in EPS / EPS at normal
23%
-39%
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