Question

Sunrise, Inc., has no debt outstanding and a total market value of $320,000. Earnings before interest and taxes, EBIT, are projected to be $47,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 19 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $165,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. The company has a tax rate of 25 percent, a market-to-book ratio of 1.0, and the stock price remains constant. 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

C E F Share price G $40 H =320000/8000 I - x for =B4*(1-30%) A B C D 1 Before recapitalisation: 2 3 Normal Recession Expansion 4 EBIT $ 47,000 $ 32,900 $ 55,930 5 Less: Interest $ - $ - $ . 6 Profit before tax $ 47,000 $ 32,900 $ 55,930 7 Less: Tax 25% $ 11,750$ 8,225 $ 13,983 8 Net income $ 35,250 $ 24,675 $ 41,948 9 = Number of shares 8,000 8,000 18,000 10 EPS $ 4.41 $ 3.08 $ 5.24 11 12 % change in EPS -30.00% 19.00% 13 14 After recapitalisation: a-1) Recession Normal Expansion $ 3.08 $ 4.41 $ 5.24 a-2) Recession Expansion -30.00% 19.00% b-1) Recession Normal Expansion $ 4.45 $ 7.18 $ 8.91 15 b-2) Recession Expansion -38.01% 24.07% 16 17 EBIT 18 Less: Interest 19 Profit before tax 20 Less: Tax 25% 21 Net income 22 : Number of shares 23 EPS Normal Recession Expansion $ 47,000 $ 32,900 $ 55,930 $ 9,900 $ 9,900 $ 9,900 =165000*6% $ 37,100 $ 23,000 $ 46,030 $ 9,275 $ 5,750 $ 11,508 $ 27,825 $ 17,250 $ 34,523 3,875 3,875 3,875 | =8000-165000/40 | $ 7.18 $ 4.45 $ 8.91 24 25 % change in EPS -38.01% 24.07%

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