Pendergrast, Inc., has no debt outstanding and a total market value of $150,000.
ID: 2722862 • Letter: P
Question
Pendergrast, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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 25 percent lower. Pendergrast is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem.
Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and 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.(Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Pendergrast, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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 25 percent lower. Pendergrast is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem.
Explanation / Answer
a-1.
EBIT (A)
No. of shares outstanding (B)
Earnings per share (A/B)
Recession
$28,000 * (1 - 0.25)
$21,000
10,000
$2.10
Normal
$28,000
10,000
$2.80
Expansion
$28,000 * (1 + 0.20)
$33,600
10,000
$3.36
a-2.
Earnings per share
EPS under Normal economy
Change in EPS
Percentage change in EPS
Recession
$2.10
$2.80
-$0.70
-25%
Expansion
$3.36
$2.80
$0.56
20%
b-1.
Market value of Firm = Market value of 10,000 shares = $150,000
Market value per share = $150,000/10,000 shares = $15 per share
Fund raised by issuing debt = $60,000
No. of shares repurchased = $60,000/$15 = 4,000 shares
No. of shares outstanding after recapitalization = 10,000 - 4,000 = 6,000 shares
Interest on debt = $60,000 * 7% = $4,200
EBIT (A)
Interest on debt (B)
Net Income (C)
No. of shares outstanding (D)
Earnings per share
(A-B)
(C/D)
Recession
$21,000
$4,200
$16,800
6,000
$2.80
Normal
$28,000
$4,200
$23,800
6,000
$3.97
Expansion
$33,600
$4,200
$29,400
6,000
$4.90
b-2.
Earnings per share
EPS under Normal economy
Change in EPS
Percentage change in EPS
Recession
$2.80
$3.97
-$1.17
-29.47%
Expansion
$4.90
$3.97
$0.93
23.43%
EBIT (A)
No. of shares outstanding (B)
Earnings per share (A/B)
Recession
$28,000 * (1 - 0.25)
$21,000
10,000
$2.10
Normal
$28,000
10,000
$2.80
Expansion
$28,000 * (1 + 0.20)
$33,600
10,000
$3.36
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