1.value: 5.00 points Kaelea, Inc., has no debt outstanding and a total market va
ID: 2630947 • Letter: 1
Question
1.value: 5.00 points Kaelea, Inc., has no debt outstanding and a total market value of $63,000. Earnings before interest and taxes, EBIT, are projected to be $8,600 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 21 percent higher. If there is a recession, then EBIT will be 34 percent lower. Kaelea is considering a $21,300 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,200 shares outstanding. Assume Kaelea has a tax rate of 40 percent. Requirement 1: (a) Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations. 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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.) %EPS Recession % Expansion % Requirement 2: Assume Kaelea goes through with recapitalization. (a) Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. 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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).) %EPS Recession % Expansion %
Explanation / Answer
Under Normal Economic Conditions
EPS = EBIT/shares outstanding = $8600/4200 = $2.05
Under Expansionary Times:
EPS = [EBIT x 1.21]/shares outstanding = $8600(1.21)/4200 = $2.48
Under a Recession:
EPS = [EBIT x (1-.34)]/shares outstanding =$8600(0.66)/4200 = 1.35
b)
when normal to expansion
change in EPS = 2.58 - 2.05/2.05 = 25.85%
when normal to recession
change in EPS = 1.35-2.05/2.05 = -34.15%
requirement 2:
If the market value of the firm is $63,000 with 4200 shares outstanding, then
the value of one share of stock is: $63,000/4200 = $15/share.
If $21,300 worth of debt is raised to retire stock, then you will be buying back
$21,300/$15 or 1,420 shares. So, after recapitalization there will be 4200 -1,420
or 2780 shares outstanding.
EBIT will be reduced by the amount of the interest on $21,300 in debt or
$21300 x .08 = $1704.
Under Normal Economic Conditions
EPS = EBIT-1704/shares outstanding = $6896/2780 = $2.48
Under Expansionary Times:
EPS = [EBIT x 1.21]-1704/shares outstanding = $8702/2780 = $3.13
Under a Recession:
EPS = [EBIT x (1-.34)]-1704/shares outstanding =$3972/2780 = 1.43
when normal to expansion
change in EPS = 3.13 - 2.48/2.48 = 26.21%
when normal to recession
change in EPS = 1.43-2.48/2.48 = -42.34%
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