Pendergast, Inc., has no debt outstanding and a total market value of $141,000.

Question

Pendergast, Inc., has no debt outstanding and a total market value of $141,000. Earnings before interest and taxes, EBIT, are projected to be $9,100 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. Pendergast is considering a $44,100 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,700 shares outstanding. Ignore taxes for this problem.

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. Round your answers to 2 decimal places (e.g., 32.16).)

%EPS
  Recession %
  Expansion %

Requirement 2:

Assume Pendergast 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. (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

Earnings Per Share= Earnings/ No of shares

Normal= 9100/4700 = $ 1.94 per share

Expansion= Earnings= 9100*121%= 11011

EPS= 11011/4700 = $ 2.34 per share

Percentage Change= 2.34-1.94/1.94= 20.6% Increase

Recession= Earnings= 9100(1-.34)=6006

EPS=6006/4700 = $ 1.28 per share

Percentage Change= 1.28-1.94/1.94 = 34% decrease

After Recapitalization

Debt Issued= 44100

Interest= 44100*5%= 2205

Earnings

Normal= 9100-2205 = 6895

Market price per share=141000/4700= $ 30

Shares purchased=44100/30= 1470

Total Shares= 4700+1470= 6170

EPS= 6895/6170= $ 1.12

Expansion=11011-2205= 8806

EPS= 8806/6170= $ 1.43

% change=1.43-1.12/1.12= 27.67% increase

Recession=6006-2205= 3801

EPS= 3801/6170= $.62per share

.62-1.12/1.12= 49.4$ decrease

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