. Buchanan Brothers anticipates that its net income at the end of the year will
ID: 2797481 • Letter: #
Question
. Buchanan Brothers anticipates that its net income at the end of the year will be $3.6 million (before any recapitalization). The company currently has 900,000 shares of common stock outstanding and has no debt. The company’s stock trades at $40 a share. The company is considering a recapitalization, where it will issue $10 million worth of debt at a yield to maturity of 10 percent and use the proceeds to repurchase common stock. Assume the stock price remains unchanged by the transaction, and the company’s tax rate is 34 percent. What will be the company’s earnings per share, if it proceeds with the recapitalization?
Explanation / Answer
Share Capital = 900,000 * 40 = $36,000,000
Debt @ 10% issued to repurchase shares = $10,000,000
New Share Capital = 36,000,000 - 10,000,000 = $26,000,000
No. of shares outstanding after recapitalization = 26,000,000 / 40 = 650,000
Net Income = 3,600,000
Tax Rate = 34%
Profit Before tax = EBIT before recapitalization = EBIT(1- 0.34) = 3,600,000
EBIT = 3,600,000 / 0.66 = $5,454,545.45
Now,
Items Amount in $ EBIT 5,454,545 Less: Interest on Debt @10% -1,000,000 Earnings before Tax 4,454,545 Less: Tax @ 34% -1,514,545 Net Income 2,940,000 No. Of Shares 650,000 Earnings Per Share $4.523Related Questions
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