Question

Sunrise, Inc., has no debt outstanding and a total market value of $220,000. 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 15 percent higher. If there,is a recession, then EBIT will be 20 percent lower. The company is considering a $120,000 Debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios.

1a. Calculate earnings per share under each of the,three,economic scenarios before any debt is issued.

2a. Calculate e as brings per share under each of thw three economic scenarios assuming the company goes through with recapitalization.

1b. Calculate earnings per share under each of the,threw economic scenarios assuming the company goes through with recapitalization.

2b. Given the,recapitalization, calculate the,percentage changes in,EPS when the economy expands or enters a recession.

1a. Recession EPS=
        Normal EPS=
        Expansions=

2a. Recession percentage change in EPS=
       Expansions percentage change in EPS=

1b. Recession EPS=
        Normal EPS=

2b. Expansion EP
        Recession percentage change in EPS

Answer 1

a-1 Calculation of EPS:

	Recession	Normal	Expansion
EBIT	20,800	26,000	29,900
Less: Interest	0	0	0
EBT	20,800	26,000	29,900
Number of shares	11,000	11,000	11,000
EPS	1.89	2.36	2.72

a-2

recession = (1.89-2.36)/2.36 = -19.92% or 20%

Expansion = (2.72-2.36)/2.36 = 15.25%

b-1

After recapitalization

Price per share = 220,000/11,000 = $20

Number of shares repurchased = 120,000/20 = 6,000 shares

	Recession	Normal	Expansion
EBIT	20,800	26,000	29,900
Less: Interest	9,600	9,600	9,600
EBT	11,200	16,400	20,300
Number of shares	5,000	5,000	5,000
EPS	2.24	3.28	4.06

B-2 % Change

Recession = (2.24-3.28)/3.28 = -31.71%

Expansion = (4.06-3.28)/3.28 = 23.78%