Beckett, Inc. has no debt outstanding and a total market value of $150,000. Earn

Question

Beckett, Inc. has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 25% lower. Beckett is considering a debt issue of $95,000 with an interest rate of 8%. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. The company has a tax rate of 35 percent.

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

EPS-Recession $_________, Normal $__________, Expansion $________ 2. Calculate the percentage changes in EPS when the economy expands or enters a recession. (Do not round. (32.16).

Recession ______%, Expansion _______% 3. Calculat earnings per share EPS under each of the three economic scenarios assuming the company goes through recapitalization. Recession $______, Normal $________, Expansion $________. 4. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amts. should be indicated by a minus sign, Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal points. (e.g., 32.16). Percentage change in EPS - Recession _____%, Expansion ________%

Explanation / Answer

Market condition EBIT Normal $36,000.00 Expansion $41,400.00 Recession $27,000.00 Answer 1 : Calculation of EPS before any debt is issued Market condition EBIT Tax @ 35% Profit after tax No.of shares outstanding EPS Normal $36,000.00 $12,600.00 $23,400.00 6000 $3.90 Expansion $41,400.00 $14,490.00 $26,910.00 6000 $4.49 Recession $27,000.00 $9,450.00 $17,550.00 6000 $2.93 % change in EPS when economy expands = (4.49 - 3.90) / 3.90 = 15% change % change in EPS when economy enters into recession = (3.90 - 2.93) / 3.90 = 25% change Answer 2 : Calculation of EPS after recapitalisation Debt issue at 8% interest = $95000 Market value per share = $150000 / 6000 shares = $25 per share Shares repurchased using debt proceeds = $95000 / $25 = 3800 shares Outstanding shares after stock repurchase = 6000 - 3800 = 2200 shares Calculation of EPS Market condition EBIT Debt Interest Profit before tax Tax @ 35% Profit after tax No.of shares outstanding EPS Normal $36,000.00 $7,600.00 $28,400.00 $9,940.00 $18,460.00 2200 $8.39 Expansion $41,400.00 $7,600.00 $33,800.00 $11,830.00 $21,970.00 2200 $9.99 Recession $27,000.00 $7,600.00 $19,400.00 $6,790.00 $12,610.00 2200 $5.73 % change in EPS when economy expands = (9.99 - 8.39) / 8.39 = 19.01% change % change in EPS when economy enters into recession = (8.39 - 5.73) / 8.39 = 31.69% change

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