Question

Sunrise, Inc., has no debt outstanding and a total market value of $245,000. Earnings before interest and taxes, EBIT, are projected to be $19,000 if economic condition is normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 40 percent lower. The company is considering a $58,800 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Assume the stock price is constant under all scenarios. Assume the company has a tax rate of 21 percent. (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. (b) Repeat part (a) assuming that the company goes through with recapitalization. What do you observe?

Answer 1

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C w ENG 06:36 30-07-2020 99+ 30 Х DA522 . CZ DA DB DC DD DE DF DG 520 521 522 523 524 MARKET VALUE OF EQUITY 245000 525 NO OF SHARES 5000 P MARKET PRICE 49 526 527 528 NO DEBT 529 530 531 STATE OF ECONOMY 40% lower RECESSION NORMAL 11400 19000 25% higher EXPANSION 23750 EBIT LESS 0 0 0 532 533 534 535 INTEREST PBT TAX 11400 19000 3990 23750 4987.5 2394 536 9006 15010 18762.5 ANS PAT (Q) EARNINGS PER SHARE (Q/P) 1.80 3.00 3.75 537 a-1 538 539 540 a-2 541 542 ANS %CHANGE IN EPS -40.00% [=(DC537-DD537)/DD537] 25.00% [=(DE537-DD537)/DD537] 543 retirement futures margin PV, FV, ANNUITY ACC CVP KE BOND HPR REALISED YIELD NPV std costing EPS%, ECONOMY, BEFORE AFTER BUYBACK ... ..

C w ENG 06:38 30-07-2020 99+ 30 Х DF563 . CZ DA DB DC DD DE DF DG 543 DEBT 40% lower RECESSION 544 545 546 547 548 549 550 551 STATE OF ECONOMY 25% higher NORMAL STRONG 11400 19000 23750 LESS 4704 4704 4704 6696 14296 EBIT INTEREST (58800 X 8%) PBT TAX PAT (Q) EARNINGS PER SHARE (Q/P1) 19046 3999.66 1406.16 3002.16 552 5289.84 11293.84 15046.34 ANS 1.39 2.97 3.96 553 b-1 554 ANS %CHANGE IN EPS -53.16% [=(DC553-DD553)/DD553] 33.23% [=(DE553-DD553)/DD553] 555 556 5-2 557 558 559 560 561 NOTE DEBT ISSUED 58800 1200 [58800/49] NO OF SHARES REPURCHASED = DEBT ISSUED/ MARKET PRICE PER SHARE 562 NO OF SHARES LEFT AFTER REPURCHASE 3800 (5000-1200] P1 563 564 565 a-1 566 RECESSION EPS NORMAL EPS futures margin PV, FV, ANNUITY 1.80 3.00 BOND HPR REALISED YIELD retirement ACC CVP KE NPV std costing EPS%, ECONOMY, BEFORE AFTER BUYBACK ... ..

C w ENG 06:38 30-07-2020 99+ 30 Х DF586 . CZ DA DB DC DD DE DF DG 563 1.80 3.00 3.75 -40.00% 25.00% 564 565 a-1 566 567 568 a-2 569 570 b-1 571 572 573 6-2 574 575 576 577 578 579 580 RECESSION EPS NORMAL EPS EXPANSION EPS RECESSION % CHANGE IN EPS EXPANSION % CHANGE IN EPS RECESSION EPS NORMAL EPS EXPANSION EPS RECESSION % CHANGE IN EPS EXPANSION % CHANGE IN EPS 1.39 2.97 3.96 -53.16% 33.23% 581 582 583 584 585 586 retirement futures margin PV, FV, ANNUITY ACC CVP KE BOND HPR REALISED YIELD NPV std costing EPS%, ECONOMY, BEFORE AFTER BUYBACK