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Fujita, Incorporated, has no debt outstanding and a total market value of $222,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 shares outstanding. Ignore taxes for this problem.  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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Question

Fujita, Incorporated, has no debt outstanding and a total market value of 222,000.Earningsbeforeinterestandtaxes,EBIT,areprojectedtobe222,000. Earnings before interest and taxes, EBIT, are projected to be 18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 shares outstanding. Ignore taxes for this problem.  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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

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Solution

a-1. To calculate the earnings per share (EPS) under each of the three economic scenarios before any debt is issued, we first need to know the EBIT under each scenario.

  • Normal conditions: EBIT = $18,000
  • Strong expansion: EBIT = 18,000∗1.25=18,000 * 1.25 = 22,500
  • Recession: EBIT = 18,000∗0.70=18,000 * 0.70 = 12,600

Next, we divide each EBIT by the number of shares outstanding to get the EPS:

  • Normal conditions: EPS = 18,000/7,400=18,000 / 7,400 = 2.43
  • Strong expansion: EPS = 22,500/7,400=22,500 / 7,400 = 3.04
  • Recession: EPS = 12,600/7,400=12,600 / 7,400 = 1.70

a-2. To calculate the percentage changes in EPS when the economy expands or enters a recession, we subtract the normal EPS from the expanded or recession EPS, divide by the normal EPS, and multiply by 100:

  • Expansion: ((3.04 - 2.43) / 2.43) * 100 = 25.10%
  • Recession: ((1.70 - 2.43) / 2.43) * 100 = -30.04%

b-1. To calculate the EPS under each of the three economic scenarios assuming the company goes through with recapitalization, we first need to calculate the EBIT minus the interest on the new debt:

  • Normal conditions: EBIT = 18,000−(18,000 - (60,000 * 0.07) = $14,800
  • Strong expansion: EBIT = 22,500−(22,500 - (60,000 * 0.07) = $19,300
  • Recession: EBIT = 12,600−(12,600 - (60,000 * 0.07) = $9,400

Next, we divide each EBIT by the number of shares outstanding after the repurchase. Assuming the repurchase price is the same as the current market price, the company can repurchase 60,000/(60,000 / (222,000 / 7,400) = 2,000 shares, leaving 5,400 shares outstanding:

  • Normal conditions: EPS = 14,800/5,400=14,800 / 5,400 = 2.74
  • Strong expansion: EPS = 19,300/5,400=19,300 / 5,400 = 3.57
  • Recession: EPS = 9,400/5,400=9,400 / 5,400 = 1.74

b-2. To calculate the percentage changes in EPS when the economy expands or enters a recession, we subtract the normal EPS from the expanded or recession EPS, divide by the normal EPS, and multiply by 100:

  • Expansion: ((3.57 - 2.74) / 2.74) * 100 = 30.29%
  • Recession: ((1.74 - 2.74) / 2.74) * 100 = -36.50%

This problem has been solved

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