Question

Intro

Zambezi Corp. expects EBIT to vary with the state of the economy as follows:

State of economy	EBIT (in $ million)
Boom	560
Base	125
Bust	-200

Zambezi doesn't have any long-term debt and has 81 million shares outstanding, currently trading at $8.42. Because of political connections, it doesn't pay any taxes.

Part 1

What are the expected earnings per share (EPS) during a boom?

Correct ✓

Since the company doesn't have any debt, it doesn't pay interest. It also doesn't pay taxes. Therefore, EBIT and net income are the same in this case:

EPS=Net incomeNumber of shares outstanding=56081=EPS=Net incomeNumber of shares outstanding=56081= 6.91

Part 2

What are the expected earnings per share (EPS) during a bust?

Correct ✓

EPS=Net incomeNumber of shares outstanding=−20081=EPS=Net incomeNumber of shares outstanding=-20081= -2.47

.

Part 3

Zambezi now issues bonds worth $33 million to buy back some shares. How many shares are outstanding after the restructuring (in million)?

Answer 1

1). As the company doesn't have any taxes and debt, its EBIT is equal to Net Income.

So, EPS(Boom) = Net Income(Boom) / No. of shares outstanding

= $560 million / 81 million = $6.91

2). EPS(bust) = Net Income(bust) / No. of shares outstanding

= -$200 million / 81 million = -$2.47

3). No. of shares repurchased = Amount of Debt / Current Share Price

= $33 million / $8.42 = 3.92 million shares

Shares outstanding after restructuring = Shares outstanding before restructuring - No. of shares repurchased

= 81 million - 3.92 million = 77.08 million shares