Question: Beckett, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $42,000 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 30 percent lower. Beckett is considering a debt issue of $100,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. The company has a tax rate 35 percent. Assume the stock price remains constant.
a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.
EPS:
Recession $
Normal $
Expansion $
a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession.
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.
EPS:
Recession $
Normal $
Expansion $
b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.
Percentage changes in EPS:
Recession %
Expansion %