Question

Beckett, Inc., has no debt outstanding and a total market value of $ 120,000. Earnings before interest and taxes, EBIT, are projected to be $ 11,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 24 percent higher. If there is a recession, then EBIT will be 48 percent lower. Beckett is considering an $ 48,000 debt issue with a 4 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes for this problem.

Required:

(a)

Earnings per share, EPS, for the recession, normal, and expansion scenarios before any debt is issued are $ , $ , and $ , respectively (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16)). If the economy enters a recession or expands, EPS will change by percent or percent, respectively (Negative amount should be indicated by a minus sign. Do not include the percent signs (%). Do not round interim calculations. Round your answers to 2 decimal places. (e.g., 32.16)).

(b)

Now assume that Beckett goes through with recapitalization. Earnings per share, EPS, for the recession, normal, and expansion scenarios are $ , $ , and $ , respectively (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16)). If the economy enters a recession or expands, EPS will change by  percent or  percent, respectively (Negative amount should be indicated by a minus sign. Do not round interim calculations. Do not include the percent signs (%). Round your answers to 2 decimal places. (e.g., 32.16)).

Answer 1

a)

Beckett	Expansion	Normal	Recession
EBIT	13,640	11,000	5,720
Taxes	0	0	0
Profits	13,640	11,000	5,720
EPS	6.82	5.50	2.86
% Change	24.0%		-48.0%

EPS = Profits / No. of shares

Share Price = Value / No. of shares = 120,000 / 2,000 = $60

With $48,000 in debt, no. of shares repurchased = 48,000 / 60 = 800 shares

New outstanding shares with debt = 2,000 - 800 = 1,200 shares

With Debt	Boom	Normal	Recession
EBIT	13,640	11,000	5,720
Interest	-1,920	-1,920	-1,920
EBT	11,720	9,080	3,800
Taxes	0	0	0
Profits	11,720	9,080	3,800
EPS	9.77	7.57	3.17
% Change	29.1%		-58.1%