Beckett, Inc., has no debt outstanding and a total market value of $200,000. Ear

Question

Beckett, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. Beckett is considering a debt issue of $70,000 with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 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 final answers to 2 decimal places (e.g., 32.16).) 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 b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).) EPS b-2. 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. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

a-1) Calculation of EPS per share in each of following three situations:

a-2) Pecentage change in EPS when economy expands= ($3.45- $ 3.0)/$ 3.0 = 15%

Pecentage change in EPS when economy enters recession= ($2.1- $ 3.0)/$ 3.0 = -30%

b-1) When the company enters recapitalisation:

Market price per share = Market capitalization/No. of shares Outstanding = $200,000/8000 = $ 25 per share

No. of share bought back with debt proceeds = $70,000/ $ 25 = 2,800 shares

Shares outstanding = 8,000- 2,800 = 5,200

b-2) After recapitalisation

Pecentage change in EPS when economy expands= ($4.37- $ 3.67)/$ 3.67 = 19.07%

Pecentage change in EPS when economy enters recession= ($2.29- $ 3.67)/$ 3.67 = -37.60%

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