RAK, Inc., has no debt outstanding and a total market value of $240,000. Earning
ID: 2732493 • Letter: R
Question
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 12,000 shares outstanding. Ignore taxes for this problem.
*I only need help with part B*
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.)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 12,000 shares outstanding. Ignore taxes for this problem.
*I only need help with part B*
Explanation / Answer
a-1.
EPS (Normal) = 28000/12000 = 2.33
EPS (Expansion) = 28000(1.12) / 12000 = 2.61
EPS (Recession) = 28000 (075) / 12000 = 1.75
a-2. % change in EPS (Expansion) = (2.61-2.33) / 2.33 x 100 = 12.02%
% change in EPS (Recession) = (1.75-2.33) / 2.33 x 100 = -24.89%
b-1. Share price = 240000/12000 = $20
No. of shares repurchased = 140000/20 = 7000 shares
Shares after repurchase = 12000-7000 = 5000 shares
EPS(normal) = 28000 / 5000 = 5.60
EPS (expansion) = 28000(1.12) / 5000 = 6.27
EPS (recession) = 28000(0.75) / 5000 = 4.20
b-2. % change in EPS (expansion) = (6.27-5.60) / 5.60 x 100 = 11.96%
% change in EPS (recession) = (4.20-5.60) / 5.60 x 100 = -25%
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