a)
To determine: The earnings per shares and percentage change in earnings per share under given scenarios.
Introduction:
Earnings per share are the fraction of a firm’s profits allocated to every outstanding share of common stock. Earnings per share are used as an indicator to determine the firm’s profitability.
a)
Answer to Problem 1QP
Solution: The earnings per share value for recession is $2.75, for normal is $4.60 and for expansion is $5.75. The percentage change in earnings per share value for recession is -40%, for normal is 0% and for expansion is 25%.
Explanation of Solution
Calculate the earnings per share (EPS) for the three economic scenarios before any debts issued:
Particulars | Recession | Normal | Expansion |
EBIT | $13,800 | $23,000 | $28,750 |
Less: Interest | $0 | $0 | $0 |
Net income | $13,800 | $23,000 | $28,750 |
Earnings per share | $2.76 | $4.60 | $5.75 |
Percentage change in EPS | -40% | 0% | 25% |
NOTE:
Calculate the earnings before interest and taxes (EBIT):
It is given that earnings before interest and taxes (EBIT) value is $23,000 when the condition is normal. If there is recession, EBIT will be 40% lower and during expansion it will be 25% higher.
Recession:
Earnings before interest and taxes (EBIT):
Therefore, the earnings before interest and taxes for recession is $13,800.
Expansion:
Earnings before interest and taxes (EBIT):
Therefore, the earnings before interest and taxes for expansion is $28,750.
Calculate the earnings per share (EPS):
The net income value for recession, normal and expansion are $6,720, $15,920 and $21,670 respectively. It is given that shares outstanding are 5,000.
Recession:
Earnings per share (EPS):
Therefore, the earnings per share for recession is $2.76.
Normal:
Earnings per share (EPS):
Therefore, the earnings per share for normal is $4.60.
Expansion:
Earnings per share (EPS):
Therefore, the earnings per share for expansion is $5.75.
Calculate the percentage change in EPS:
Recession:
Therefore, the percentage change in EPS is -40%.
Normal:
Therefore, the percentage change in EPS is 0%.
Expansion:
Therefore, the percentage change in EPS is 25%.
b)
To determine: The earnings per shares and percentage change in earnings per share when company goes through recapitalization.
b)
Answer to Problem 1QP
Solution: The earnings per share value for recession is $1.92, for normal is $4.55 and for expansion is $6.19. The percentage change in earnings per share value for recession is -57.79%, for normal is 0% and for expansion is 36.12%.
Explanation of Solution
When company goes through recapitalization, then it will have to repurchase.
Calculate the share price:
It is given that the market value is $295,000 and shares outstanding are 5,000.
Therefore, the share price is $59.
Calculate the shares repurchased:
It is given that the company is considering issuing $88,500 debts.
Therefore, the shares repurchased are 1,500.
Calculate the interest payment for each year:
It is given that the company is considering issuing $88,500 debts and interest payment is 8%.
Therefore, the interest payment is $7,080.
Now, calculate the earnings per share.
Particulars | Recession | Normal | Expansion |
EBIT | $13,800 | $23,000 | $28,750 |
Less: Interest | $7,080 | $7,080 | $7,080 |
Net income | $6,720 | $15,920 | $21,670 |
Earnings per share | $1.92 | $4.55 | $6.19 |
Percentage change in EPS | -57.79% | 0% | 36.12% |
NOTE:
Calculate the earnings before interest and taxes (EBIT):
It is given that earnings before interest and taxes (EBIT) value is $23,000 when the condition is normal. If there is recession, EBIT will be 40% lower and during expansion it will be 25% higher.
Recession:
Earnings before interest and taxes (EBIT):
Therefore, the earnings before interest and taxes for recession is $13,800.
Expansion:
Earnings before interest and taxes (EBIT):
Therefore, the earnings before interest and taxes for expansion is $28,750.
Calculate the earnings per share (EPS):
The net income value for recession, normal and expansion are $13,800, $23,000 and $28,750 respectively. It is given that shares outstanding are 5,000.
Recession:
Earnings per share (EPS):
Therefore, the earnings per share for recession is $1.92.
Normal:
Earnings per share (EPS):
Therefore, the earnings per share for normal is $4.55.
Expansion:
Earnings per share (EPS):
Therefore, the earnings per share for expansion is $6.19.
Calculate the percentage change in EPS:
Recession:
Therefore, the percentage change in EPS is -57%.
Normal:
Therefore, the percentage change in EPS is 0%.
Expansion:
Therefore, the percentage change in EPS is 36%,
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Chapter 16 Solutions
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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