Pendergrast, Inc., has no debt outstanding and a total market value of $240,000.
ID: 2743661 • Letter: P
Question
Pendergrast, Inc., has no debt outstanding and a total market value of $240,000. 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 10 percent higher. If there is a recession, then EBIT will be 25 percent lower. Pendergrast is considering a $48,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 20,000 shares outstanding. Ignore taxes for this problem.
a-1 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) EPS Recession Normal Expansion 1.05 1.40 1.54 a-2 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.) Percentage changes in EPS -25 % 10 % Recession ExpansionExplanation / Answer
Pendergrast, Inc. All Amounts in $ b-1. If the Company goes through with recapitalisation EBIT under different scenarios will be Normal 26080 $ 28,000 less 4% of $ 48,000 Recession 19560 25% lower than Normal Expansion 28688 10% higher than Normal No. of shares outstanding Existing 20000 Repurchase from Debt 4800 $ 48,000 / $ 10 per share (Face Value) Total Shares 24800 EPS under different scenarios EPS = EBIT / No. of shares outstanding Normal 1.051613 $ per share Recession 0.78871 $ per share Expansion 1.156774 $ per share b-2. % Change in EPS when the economy enters a recession or expands Recession -25.00% Expansion 10.00%
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