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. 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.)

Answer 1

Before recapitalisation: Affter recapitalisation: Expansion $29,900 $9,600 $20,300 Normal Particulars Recession Expansion Particulars Recession Normal $29,900 $0 $26,000 $9,600 $20,800 $26,000 $20,800 EBIT EBIT $9,600 $0 $0 less: less: Interest Interest $20,800 $29,900 $16,400 $26,000 $11,200 ЕВT ЕВT $0 $0 $0 $0 $0 $0 less: less: Тах Тах $20,800 $26,000 $29,900 $20,300 $11,200 $16,400 Net income Net income number of shares number of shares 11000 11000 11000 5000 5000 5000 EPS Net income/shares EPS Net income/shares $1.89 $2.36 $2.72 $2.24 $3.28 $4.06 а1) b-1) percentage change in EPS: а-2) b-2) percentage change in EPS: (2.24-3.28) 3.28 -20.00% Recession (1.89-2.36) 2.36 Recession -31.71% Expansion 15.00% (2.72-2.36) 2.36 Expansion 23.78% (4.06-3.28)+3.28