Question

Fujita, Incorporated, has no debt outstanding and a total market value of $240,900. Earnings before interest and taxes, EBIT, are projected to be $40,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 14 percent higher. If there is a recession, then EBIT will be 25 percent lower. The company is considering a $130,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,300 shares outstanding. The company has a tax rate of 23 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.) a-1. Recession EPS a-1. Normal EPS a-1. Expansion EPS a-2. Recession percentage change in EPS a-2. Expansion percentage change in EPS b-1. Recession EPS b-1. Normal EPS b-1. Expansion EPS % % % % a-1. Recession EPS a-1. Normal EPS a-1. Expansion EPS a-2. Recession percentage change in EPS a-2. Expansion percentage change in EPS b-1. Recession EPS b-1. Normal EPS b-1. Expansion EPS b-2. Recession percentage change in EPS b-2. Expansion percentage change in EPS % %

Answer 1

This detailed answer provides step-by-step calculations for earnings per share and percentage changes in EPS under different economic scenarios before and after issuing debt.

Step-by-step explanation:

a-1. Earnings per share (EPS) under each economic scenario before debt is issued:

• Recession: EPS = (EBIT*(1-Tax rate)) / Number of shares
  EPS = (40,000*(1-0.23)) / 7,300 = $2.84
• Normal: EPS = (EBIT*(1-Tax rate)) / Number of shares
  EPS = (40,000*(1-0.23)) / 7,300 = $2.84
• Expansion: EPS = (1.14*EBIT*(1-Tax rate)) / Number of shares
  EPS = (1.14*40,000*(1-0.23)) / 7,300 = $3.26

a-2. Percentage change in EPS during a recession and expansion:

• Recession: ((Recession EPS - Normal EPS) / Normal EPS) * 100
  ((2.84 - 2.84) / 2.84) * 100 = 0%
• Expansion: ((Expansion EPS - Normal EPS) / Normal EPS) * 100
  ((3.26 - 2.84) / 2.84) * 100 = 14.79%

b-1. Earnings per share (EPS) under each economic scenario after debt is issued:

• Recession: EPS = (EBIT*(1-Tax rate)) / Number of shares
  EPS = (40,000*(1-0.23)) / 7,300 = $2.84
• Normal: EPS = (EBIT*(1-Tax rate) - Interest expense) / Number of shares
  EPS = (40,000*(1-0.23) - (130,000*0.07*(1-0.23))) / 7,300 = $2.76
• Expansion: EPS = (1.14*EBIT*(1-Tax rate) - Interest expense) / Number of shares
  EPS = (1.14*40,000*(1-0.23) - (130,000*0.07*(1-0.23))) / 7,300 = $3.18

b-2. Percentage change in EPS during a recession and expansion after debt is issued:

• Recession: ((Recession EPS - Normal EPS) / Normal EPS) * 100
  ((2.84 - 2.76) / 2.76) * 100 = 2.9%
• Expansion: ((Expansion EPS - Normal EPS) / Normal EPS) * 100
  ((3.18 - 2.76) / 2.76) * 100 = 15.22%