Kaelea, Inc., has no debt outstanding and a total market value of $106,000. Earn
ID: 2646520 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $106,000. Earnings before interest and taxes, EBIT, are projected to be $9,700 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 33 percent lower. Kaelea is considering a $30,600 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,300 shares outstanding. Assume Kaelea has a tax rate of 30 percent.
Requirement 2:
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).)
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).)
Assume Kaelea goes through with recapitalization.Explanation / Answer
Solution : Figures in $ As of now Kaelea, Inc., has no debt so total market value belongs to market value of equity only. so market price per share = total market value / no of share oustanding = 106000 / 5300 = 20 Debt to be issued = 30600 So now of share to be repurchase = 30600 / 20 = 1530 No of share O/S post repurchase: = 5300 -1530 = 3770 shares [1] Calculation of EPS post Repurchase: Condition normal strong recession EBIT 9700 11834 6499 (-) Interest (30600 * 7%) 2142 2142 2142 EBT 7558 9692 4357 (-) TAX 30% 2267.4 2907.6 1307.1 EAT (A) 5290.6 6784.4 3049.9 (For shareholder) No of shares (B) 3770 3770 3770 EPS (A/B) 1.40 1.80 0.81 [2] Percentage change (Recession) = (EPS in recession – EPS in normal)/EPS in normal = (0.81-1.40)/1.40 = -42.14% Percentage change (Expansion) = (EPS in Expansion – EPS in normal)/EPS in normal = (1.8-1.40)/1.40 = 28.57%
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