Pendergast, Inc., has no debt outstanding and a total market value of $82,000. E
ID: 2793272 • Letter: P
Question
Pendergast, Inc., has no debt outstanding and a total market value of $82,000. Earnings before interest and taxes, EBIT, are projected to be $8,500 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 35 percent lower. Pendergast is considering a $28,200 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,100 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).)
Pendergast, Inc., has no debt outstanding and a total market value of $82,000. Earnings before interest and taxes, EBIT, are projected to be $8,500 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 35 percent lower. Pendergast is considering a $28,200 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,100 shares outstanding. Ignore taxes for this problem.
Explanation / Answer
Answer)
Requirement -1
Normal
Recession
Expansion
EBIT
8500
8500*(1-0.35)=5525
8500*(1.20) = 10,200
-Interest
0
0
0
EBT
8500-0 = 8500
5525-0=5525
10200-0=10200
-Taxes
0
0
0
Net Income
8500
5525
10200
EPS = Net Income / Number of share =
Normal Economy=8500/4100 =2.1
Recession = 5525/4100 =1.3
Expansion = 10200/4100 = 2.5
% Change = Recession = (1.3-2.1) / 2.1 = -35%
% Change = Expansion = (2.5-2.1)/2.1 = 20%
Requirement -2
Normal
Recession
Expansion
EBIT
8500
8500*(1-0.35)=5525
8500*(1.20) = 10,200
-Interest
28200*7% = 1974
1974
1974
EBT
8500-1974 = 6526
5525-1974=3551
10200-1974=8226
-Taxes
0
0
0
Net Income
6526
3351
8226
We will now calculate how many share we can repurchase with a debt of 28200
Share price = 82000/4100 =20
Total share to be repurchased = 28200/20 = 1410
Number of share outstanding after repurchase = 4100-1410 = 2690
New EPS =
Normal Economy=6526/2690 =2.43
Recession = 3351/2690 =1.32
Expansion = 8226/2690 = 3.06
% Change = Recession = (1.32-2.43) / 2.43 = -45.59%
% Change = Expansion = (3.06-2.43)/2.43 = 26.05%
Normal
Recession
Expansion
EBIT
8500
8500*(1-0.35)=5525
8500*(1.20) = 10,200
-Interest
0
0
0
EBT
8500-0 = 8500
5525-0=5525
10200-0=10200
-Taxes
0
0
0
Net Income
8500
5525
10200
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