Problem 13-1 EBIT and Leverage [LO 1] Kaelea, Inc., has no debt outstanding and
ID: 2645246 • Letter: P
Question
Problem 13-1 EBIT and Leverage [LO 1]
Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 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. Kaelea is considering a $42,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,250 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.)
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. (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).)
Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 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. Kaelea is considering a $42,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,250 shares outstanding. Ignore taxes for this problem.
Explanation / Answer
Requirement 1:
a)
Recession :
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS = (10400 - 35%*10400)/6250
EPS = 1.08
Normal :
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS = 10400/6250
EPS = 1.66
Expansion :
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS = (10400 + 20%*10400)/6250
EPS = 2.00
b) 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.)
Recession :
Percentage Change in EPS = (1.08-1.66)/1.66
Percentage Change in EPS = - 35 %
Expansion :
Percentage Change in EPS = (2.00-1.66)/1.66
Percentage Change in EPS = 20 %
Requirement 2:
Market Price per share = 125000/6250 = 20
No of share to be repurchase = 42000/20 = 2100
No of outstanding Share = 6250 -2100 = 4150
a) 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).)
Recession
EBIT =10400 - 35% * 10400 = 6760
Interest = 6%*42000 = 2520
EBT = 4240
Tax = 0
Earning Available to Shareholder = 4240
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS = 4240/4150
EPS = 1.02
Normal
EBIT =10400
Interest = 6%*42000 = 2520
EBT = 7880
Tax = 0
Earning Available to Shareholder = 7880
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS =7880/4150
EPS = 1.90
Expansion
EBIT =10400 + 20% * 10400 =12480
Interest = 6%*42000 = 2520
EBT = 9960
Tax = 0
Earning Available to Shareholder = 9960
EPS = Earning Available to Shareholder/No of Outstanding Share
EPS = 9960/4150
EPS = 2.40
b) 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).)
Recession :
Percentage Change in EPS = (1.021687-1.898795)/1.898795
Percentage Change in EPS = - 46.19 %
Expansion :
Percentage Change in EPS = (2.40-1.898795)/1.898795
Percentage Change in EPS = 26.40 %