Kaelea, Inc., has no debt outstanding and a total market value of $106,000. Earn

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. 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. 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).)

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. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places (e.g., 32.16).)

Requirement 1:

Explanation / Answer

(1) (a) Computation of the  EPS under each of the three economic scenarios before any debt is issued.We have,

(b) Computation of the percentage changes in EPS when the economy expands or enters a recession.We have,

(2) (a) Computation of the earnings per share(EPS) under each of the three economic scenarios after the recapitalization.We have,

Step1: Computation of the outstanding shares after repurchase.We have,

Price of share = Market value /Number of outstanding share = 106,000/5,300 = $ 20.00

Number of share repurchase = Value of debt / Price of share = 30,600/20 = 1,530

Number of share outstanding after repurchase = 5,300 - 1,530 = 3,770 shares

(b) Computation of the percentage changes in EPS when the economy expands or enters a recession.We have,

Particulars Normal Expansion Recession EBIT $ 9,700 $ 11,834 $ 6,499 Less: tax@30% 2,910 3,550 1,950 Earning for shareholder $ 6,790 8,284 4,549 Number of share outstanding 5,300 5,300 5,300 Earning per share(EPS) 1.28 1.56 0.86

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