Kaelea, Inc., has no debt outstanding and a total market value of $153,000. Earn

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. Kaelea 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. Assume Kaelea has a tax rate of 34 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).)

Explanation / Answer

Particulars Condition- Normal Strong Expansion Recession EBIT 9500 9500 9500+20% 11400 9500-35% 6175 No: of shares 5100 5100 5100 EBIT 9500 11400 6175 Less: Interest 0 0 0 EBT 9500 11400 6175 Less: Tax@34% 3230 3876 2099.5 Earning After Tax 6270 7524 4075.5 Requirement 1 a Earnings per share 1.23 1.48 0.80 (EAT/No: of shares) b Percentage change in EPS - 20.00 -35.00 Requirement 2 Debt raised 45300 45300 45300 Total Market Value 153000 153000 153000 No: of shares 5100 5100 5100 Market Value per share 30 30 30 (Total Market Value/ No: of shares) No: of shares that could be bought back with the debt (Debt/ Market Value per share) 1510 1510 1510 No: of shares after recapitalization 3590 3590 3590 EBIT 9500 11400 6175 Less: Interest (5%*45300) 2265 2265 2265 EBT 7235 9135 3910 Less: Tax@34% 2459.9 3105.9 1329.4 Earning After Tax 4775.1 6029.1 2580.6 a Earnings per share 1.33 1.68 0.72 (EAT/No: of shares) b Percentage change in EPS - 26.26 -45.96

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