Castle, Inc., has no debt outstanding and a total market value
of $240,000. Earnings before interest and taxes, EBIT, are
projected to be $26,000 if economic conditions are normal. If there
is strong expansion in the economy, then EBIT will be 18 percent
higher. If there is a recession, then EBIT will be 20 percent
lower. The firm is considering a debt issue of $150,000 with an
interest rate of 8 percent. The proceeds will be used to repurchase
shares of stock. There are currently 15,000 shares outstanding.
Ignore taxes for this problem.
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 answers to 2 decimal
places, e.g., 32.16.)
EPS | |||
Recession | $ | ||
Normal | $ | ||
Expansion | $ | ||
a-2. Calculate the percentage changes in EPS when the
economy expands or enters a recession. (A negative answer
should be indicated by a minus sign. Do not round intermediate
calculations. Enter your answers as a percent rounded to the
nearest whole number, e.g., 32.)
Percentage changes in EPS | ||
Recession | % | |
Expansion | % | |
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 answers to 2 decimal places, e.g.,
32.16.)
EPS | |||
Recession | $ | ||
Normal | $ | ||
Expansion | $ | ||
b-2. Given the recapitalization, calculate the percentage
changes in EPS when the economy expands or enters a recession.
(A negative answer should be indicated by a minus sign. Do
not round intermediate calculations. Enter your answers as a
percent rounded to 2 decimal places, e.g.,
32.16.)
Percentage changes in EPS | ||
Recession | % | |
Expansion | % | |
a-1.
EPS | |
Recession | $ 1.39 |
Normal | $ 1.73 |
Expansion | $ 2.05 |
a-2.
Percentage Change in EPS | |
Recession | - 20 % |
Expansion | 18 % |
b-1. Market price per share = $ 240,000 / 15,000 shares = $ 16
Number of outstanding shares after recapitalization = 15,000 - $ ( 150,000 / $ 16) = 5,625
Interest expense = $ 150,000 x 8 % = $ 12,000.
EPS | |
Recession | $ 1.56 |
Normal | $ 2.49 |
Expansion | $ 3.32 |
b-2.
Percentage Change in EPS | |
Recession | - 37.35 % |
Expansion | 33.33 % |
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