Question

Sunrise, Inc., has no debt outstanding and a total market value of $150,000. 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 12 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a $90,000 debt issue with an Interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios. 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.) 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 and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) 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.) 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 and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) a-1. PS TS 2.08 2.60 a-2. Recession EPS Normal EPS Expansion EPS Recession percentage change in EPS Expansion percentage change in EPS Recession EPS Normal EPS Expansion EPS Recession percentage change in EPS Expansion percentage change in EPS b-1. b-2.

Answer 1

A. 1	Recession	Normal	Expansion
EBIT	20800 (26000*80%)	26,000	29120 (26000*112%)
Less: Interest	-	-	-
Earnings before taxes	20800	26,000	29120
Less: Taxes	0	0	0
Net Income	20800	26,000	29120
Number of Shares	10000	10000	10000
EPS	2.08	2.60	2.912 or 2.91
A.2
% Change
Recession	= (2.08-2.60 )/2.60 =-0.52/2.60 = -20.00%	= (Recession EPS-normal EPS)/Normal EPS
Expansion	= (2.912-2.60) /2.60 = 0.312/2.60 =12%.00	= (Expansion EPS -normal EPS)/Normal EPS
B.1
	Recession	Normal	Expansion
EBIT	20800 (26000*80%)	26,000	29120 (26000*112%)
Less: Interest (debt * Interest rate )= 90000*6%	5400	5400	5400
Earnings before taxes	15400	20600	23720
Less: Taxes	0	0	0
Net Income	15400	20600	23720
Nee shares	6400	64 00	6400
EPS (Net income / Number of shares)	2.40625 or 2.41	3.21875 or 3.22	3.70625 or 3.71
B. 2 % Change
Recession	(2.40625-3.21875)/3.21875 =- 0.8125/3.21875 =-25.24%	= RecessionEPS- NormalRecession EPS)/Normal EPS
Expansion	(3.70625-3.21875)/3.21875 =0.4875/ 3.21875 = 25.15%	= (expansionEPS- normal EPS)/Normal EPS

Share price per share = Market value / no of shares outstanding
	Share price per share = $150,000 /10,000
	Share price per share = $25

Share repurchased= Debt / share per share

=90000/25=3600

New share = share outstanding - repurchased Share = 10000-3600= 6400