EBIT, Taxes, and Leverage Repeat p arts (a) and (b) in Problem 1 assuming the company has a tax rate of 35 percent.
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.
Answer to Problem 2QP
Solution: The earnings per share value for recession is $1.79, for normal is $2.99 and for expansion is $3.74. 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 |
Taxes(35% of EBIT) | $4,830 | $8,050 | $10,063 |
Net income | $8,970 | $14,950 | $18,688 |
Earnings per share | $1.79 | $2.99 | $3.74 |
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. The tax rate is 35%.
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 $8,970, $14,950 and $18,688 respectively. It is given that shares outstanding are 5,000.
Recession:
Earnings per share (EPS):
Therefore, the earnings per share for recession is $1.79.
Normal:
Earnings per share (EPS):
Therefore, the earnings per share for normal is $2.99.
Expansion:
Earnings per share (EPS):
Therefore, the earnings per share for expansion is $3.74.
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.
Answer to Problem 2QP
Solution: The earnings per share value for recession is $1.25, for normal is $2.96 and for expansion is $4.02. 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 |
EBT | $6,720 | $15,920 | $21,670 |
Taxes (35% of EBT) | $2,352 | $5,572 | $7,585 |
Net income | $4,368 | $10,348 | $14,086 |
Earnings per share | $1.25 | $2.96 | $4.02 |
Percentage change in EPS | -57.59% | 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 $4,368 , $10,348 and $14,086respectively. It is given that shares outstanding are 5,000.
Recession:
Earnings per share (EPS):
Therefore, the earnings per share for recession is $1.25.
Normal:
Earnings per share (EPS):
Therefore, the earnings per share for normal is $2.96.
Expansion:
Earnings per share (EPS):
Therefore, the earnings per share for expansion is $4.02.
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%.
The percentage change in EPS is same for both with and without taxes,
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Chapter 16 Solutions
EBK CORPORATE FINANCE
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