Question

Q1)      Jagdambay Exports has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20% higher. If there is a recession, then EBIT will be 30% lower. Jagdambay Exports is considering a $75,000 debt issue with a 7% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. The tax rate is 35%. Based on the given information, please answer questions a and b. (10 Points)

a)         Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession. (5 Points)

b) Repeat part (a) assuming that the company goes through with recapitalization. What do you observe? (5 Points)

Answer 1

		Normal	Expansionary	recessionary
EBIT		23000	27140	16100
less interest		0	0	0
EBT		23000	27140	16100
tax-35%		8050	9499	5635
after tax profit		14950	17641	10465
no of shares		6000	6000	6000
EPS	after tax profit/no of shares	2.491667	2.940167	1.744167
% change in EPS	change in EPS / EPS at normal		18%	-30%
		Normal	Expansionary	recessionary
EBIT		23000	27140	16100
less interest		5250	5250	5250
EBT		17750	21890	10850
tax-35%		6212.5	7661.5	3797.5
after tax profit		11537.5	14228.5	7052.5
no of shares	(180000-75000)/30    = 180000/60 = 30	3500	3500	3500
EPS	after tax profit/no of shares	3.296429	4.065286	2.015
% change in EPS	change in EPS / EPS at normal		23%	-39%