Beckett, Inc., has no debt outstanding and a total market value of $240,000.
Earnings before interest and taxes, EBIT, are projected to be $28,000 if
economic conditions are normal. If there is strong expansion in the economy,
then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25
percent lower. Beckett is considering a debt issue of $140,000 with an interest
rate of 6 percent. The proceeds will be used to repurchase shares of stock.
There are currently 12,000 shares outstanding. The company has a tax rate 35
percent.
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).)
EPS
Recession $ = $28000*(1.0.25)*(1-0.35)/12000 =$1.14 per share
Normal $ = $28000*(1-0.35)/12000 =$1.52 per share
Expansion $ = $28000*(1.12)*(1-0.35)/12000 = $1.70 per share
a-2.
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. Enter your answers as a percent.)
Percentage changes in EPS
Recession % = ($1.14 - $1.52)/$1.52$ = - 25%
Expansion % = (($1.70 - $1.52)/$1.52$ = 12%
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).)
If the market value of the firm is $240,000 with 12000 shares outstanding, then
the value of one share of stock is: $240,000/12,000 = $20/share.
If $140,000 worth of debt is raised to retire stock, then you will be buying back
$140,000/$20 or 7,000 shares. So, after recapitalization there will be 12000 -
7000 or 5000 shares outstanding.
EBIT will be reduced by the amount of the interest on $140,000 in debt or
$140,000 x .06 = $8400.
EPS
Recession $ =( 21000 – 8400)*(1-0.35)/5000 = $1.64
Normal $ = (28000 – 8400)*(1-0.35)/5000 = $2.55
Earnings before interest and taxes, EBIT, are projected to be $28,000 if
economic conditions are normal. If there is strong expansion in the economy,
then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25
percent lower. Beckett is considering a debt issue of $140,000 with an interest
rate of 6 percent. The proceeds will be used to repurchase shares of stock.
There are currently 12,000 shares outstanding. The company has a tax rate 35
percent.
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).)
EPS
Recession $ = $28000*(1.0.25)*(1-0.35)/12000 =$1.14 per share
Normal $ = $28000*(1-0.35)/12000 =$1.52 per share
Expansion $ = $28000*(1.12)*(1-0.35)/12000 = $1.70 per share
a-2.
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. Enter your answers as a percent.)
Percentage changes in EPS
Recession % = ($1.14 - $1.52)/$1.52$ = - 25%
Expansion % = (($1.70 - $1.52)/$1.52$ = 12%
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).)
If the market value of the firm is $240,000 with 12000 shares outstanding, then
the value of one share of stock is: $240,000/12,000 = $20/share.
If $140,000 worth of debt is raised to retire stock, then you will be buying back
$140,000/$20 or 7,000 shares. So, after recapitalization there will be 12000 -
7000 or 5000 shares outstanding.
EBIT will be reduced by the amount of the interest on $140,000 in debt or
$140,000 x .06 = $8400.
EPS
Recession $ =( 21000 – 8400)*(1-0.35)/5000 = $1.64
Normal $ = (28000 – 8400)*(1-0.35)/5000 = $2.55
