Kaelea, Inc., has no debt outstanding and a total market value of $63,000. Earni
ID: 2647601 • Letter: K
Question
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.
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).)
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.)
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).)
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.
Explanation / Answer
EPS is the acronym for earning per share which is a measure of earning after tax attributable to the shareholders. This is calculated on the number of shares outstanding at the end of the year. EPS is one of the measure to decide whether to invest in the shares of the company or not.
1. EPS calculation in all the three scenarios:
Particulars
Recession
Normal
Expansion
EBIT
$ 5,676.00
$ 8,600.00
$ 10,406.00
Interest
$ -
$ -
$ -
EBT (A)
$ 5,676.00
$ 8,600.00
$ 10,406.00
Tax at 40% (A)
$ 2,270.40
$ 3,440.00
$ 4,162.40
Earnings after tax
$ 3,405.60
$ 5,160.00
$ 6,243.60
Outstanding Shares
4,200
4,200
4,200
Earnings Per Share
$ 0.81
$ 1.23
$ 1.49
b. Changes in EPS
Change is calculated using the formula = ( Changed EPS - Previous EPS ) / Previous EPS
Scenario
% Change in EPS
Recession
-34%
Expansion
21%
2. After the recapitalization EPS under various scenarios are:
Since debt was taken of $ 21,300 at 8% interest per annum, interest cost will now be = $1,704 per annum.
But, issue proceeds were used for repurchasing the outstanding share, which current value at = $ 15 ( $ 63,000 / 4,200)
Hence in $ 21,300 we can repurchase = $ 21,300 / $ 15 = 1,420 shares
Total outstanding share after repurchase = 2,780
Particulars
Recession
Normal
Expansion
EBIT
$ 5,676.00
$ 8,600.00
$ 10,406.00
Interest
$ 1,704.00
$ 1,704.00
$ 1,704.00
EBT (A)
$ 3,972.00
$ 6,896.00
$ 8,702.00
Tax at 40% (A)
$ 1,588.80
$ 2,758.40
$ 3,480.80
Earnings after tax
$ 2,383.20
$ 4,137.60
$ 5,221.20
Outstanding Shares
2,780
2,780
2,780
Earnings Per Share
$ 0.86
$ 1.49
$ 1.88
b. Percentage changes when economy changes:
Change is calculated using the formula = ( Changed EPS - Previous EPS ) / Previous EPS
Scenario
% Change in EPS
Recession
-42%
Expansion
26%
Particulars
Recession
Normal
Expansion
EBIT
$ 5,676.00
$ 8,600.00
$ 10,406.00
Interest
$ -
$ -
$ -
EBT (A)
$ 5,676.00
$ 8,600.00
$ 10,406.00
Tax at 40% (A)
$ 2,270.40
$ 3,440.00
$ 4,162.40
Earnings after tax
$ 3,405.60
$ 5,160.00
$ 6,243.60
Outstanding Shares
4,200
4,200
4,200
Earnings Per Share
$ 0.81
$ 1.23
$ 1.49
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