Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9780077861759
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher: McGraw-Hill Education
Question
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Chapter 16, Problem 1QP

a)

Summary Introduction

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)

Expert Solution
Check Mark

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):

Earnings before interest and taxes=EBIT×(1EBIT raterecession)=$23,000×(140%)=$23,000×0.6=$13,800

Therefore, the earnings before interest and taxes for recession is $13,800.

Expansion:

Earnings before interest and taxes (EBIT):

Earnings before interest and taxes=EBIT×(1+EBIT rateExpansion)=$23,000×(1+25%)=$23,000×1.25=$28,750

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):

Earnings per share=Net incomeShares outstanding=$13,8005,000=$2.76

Therefore, the earnings per share for recession is $2.76.

Normal:

Earnings per share (EPS):

Earnings per share=Net incomeShares outstanding=$23,0005,000=$4.60

Therefore, the earnings per share for normal is $4.60.

Expansion:

Earnings per share (EPS):

Earnings per share=Net incomeShares outstanding=$28,7505,000=$5.75

Therefore, the earnings per share for expansion is $5.75.

Calculate the percentage change in EPS:

Recession:

Percentage change in EPS=(Earnings per sharerecessionEarnings per sharenormal)Earnings per sharenormal=($2.76$4.60)$4.60=$1.84$4.60=0.4or40%

Therefore, the percentage change in EPS is -40%.

Normal:

Percentage change in EPS=(Earnings per sharenormalEarnings per sharenormal)Earnings per sharenormal=($4.60$4.60)$4.60=0or0%

Therefore, the percentage change in EPS is 0%.

Expansion:

Percentage change in EPS=(Earnings per shareexpansionEarnings per sharenormal)Earnings per sharenormal=($5.75$4.60)$4.60=$1.15$4.60=0.25or25%

Therefore, the percentage change in EPS is 25%.

b)

Summary Introduction

To determine: The earnings per shares and percentage change in earnings per share when company goes through recapitalization.

b)

Expert Solution
Check Mark

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.

Share price=Market valueShares outstanding=$295,0005,000=$59

Therefore, the share price is $59.

Calculate the shares repurchased:

It is given that the company is considering issuing $88,500 debts.

Share repurchased=Debt issuedShares price=$88,500$59=1,500shares

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%.

Interest payment=Debts issued×Interest rate=$88,500×8%=$7,080

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):

Earnings before interest and taxes=EBIT×(1EBIT raterecession)=$23,000×(140%)=$23,000×0.6=$13,800

Therefore, the earnings before interest and taxes for recession is $13,800.

Expansion:

Earnings before interest and taxes (EBIT):

Earnings before interest and taxes=EBIT×(1+EBIT rateExpansion)=$23,000×(1+25%)=$23,000×1.25=$28,750

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):

Earnings per share=Net incomeShares outstandingShares repurchased=$6,7205,0001,500=$6,7203,500=$1.92

Therefore, the earnings per share for recession is $1.92.

Normal:

Earnings per share (EPS):

Earnings per share=Net incomeShares outstandingShares repurchased=$15,9205,0001,500=$15,9203,500=$4.55

Therefore, the earnings per share for normal is $4.55.

Expansion:

Earnings per share (EPS):

Earnings per share=Net incomeShares outstandingShares repurchased=$21,6705,0001,500=$21,6703,500=$6.19

Therefore, the earnings per share for expansion is $6.19.

Calculate the percentage change in EPS:

Recession:

Percentage change in EPS=(Earnings per sharerecessionEarnings per sharenormal)Earnings per sharenormal=($1.92$4.55)$4.55=$2.63$4.55=0.57or57%

Therefore, the percentage change in EPS is -57%.

Normal:

Percentage change in EPS=(Earnings per sharenormalEarnings per sharenormal)Earnings per sharenormal=($4.55$4.55)$4.55=0or0%

Therefore, the percentage change in EPS is 0%.

Expansion:

Percentage change in EPS=(Earnings per shareexpansionEarnings per sharenormal)Earnings per sharenormal=($6.19$4.55)$4.55=$1.64$4.55=0.36or36%

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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