Pendergast, Inc., has no debt outstanding and a total market value of $220,000.

Question

Pendergast, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 25 percent lower. Pendergast is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. Pendergast has a tax rate of 35 percent.

  

Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (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.)

  

  

Assume that the company goes through with recapitalization. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.(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. Round your answers to 2 decimal places. (e.g., 32.16))

  

Pendergast, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 25 percent lower. Pendergast is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. Pendergast has a tax rate of 35 percent.

Explanation / Answer

Answer:a-1

Answer:a-2

% EPS going from Normal to Expansion: ($2.51-$2.13)/$2.13 =17.84%

% EPS going from Normal to Recession: ($1.60-$2.13)/$2.13 =-24.88%

Answer:b-1 If the market value of the firm is $220,000 with 11000 shares outstanding, then the value of one share of stock is: $220,000/11000 = $20/share.

If $125,000 worth of debt is raised to retire stock, then you will be buying back $125000/$20 or 6250 shares. So, after recapitalization there will be 11000 - 6250 or 4750 shares outstanding.

EBIT will be reduced by the amount of the interest on $125,000 in debt or $125,000 x .08 = $10,000.

Answer:b-2

% EPS going from Normal to Expansion: ($4.44-$3.56)/$3.56=24.72%

% EPS going from Normal to Recession: ($2.33-$3.56)/$3.56 =-34.55%

Particulars Expansion Normal Recession EBIT 42480 36000 27000 Less: Tax 14868 12600 9450 EAT 27612 23400 17550 No of shares 11000 11000 11000 EPS 2.51 2.13 1.60

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