RAK, Inc., has no debt outstanding and a total market value of $240,000. Earning
ID: 2733525 • 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 $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $80,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 15,000 shares outstanding. Ignore taxes for this problem.
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 $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $80,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 15,000 shares outstanding. Ignore taxes for this problem.
Explanation / Answer
a -1) Calculation of EPS Normal Recession Expansion EBIT 32000 22400 36800 Less : Interest 0 0 0 Earning for share holder(a) 32000 22400 36800 No. Of Equity Shares Outstanding(b) 15000 15000 15000 EPS (a/b) 2.13 1.49 2.45 a-2) Percentage change in EPS = (EPS under normal condition - EPS under recession or expansion) / EPS under normal condition *100 Recession Expansion Percentage Change 30 15 b-1) Calculation of No. Of shares Outstanding after recapitalisation Market Value of shares 240000 Original Shares Outstanding 15000 Market Value per share 16 Debt issued for repurchase of own stock 80000 No of shares repurchase(Debt amount / Market Value of share) 5000 Shares Oustanding after repurchase 10000 Calculation of EPS after recapitalisation Normal Recession Expansion EBIT 32000 22400 36800 Less : Interest on debt @7% 5600 5600 5600 Earning for share holder(a) 26400 16800 31200 No. Of Equity Shares Outstanding(b) 10000 10000 10000 EPS (a/b) 2.64 1.68 3.12 b-2) Percentage change in EPS = (EPS under normal condition - EPS under recession or expansion) / EPS under normal condition *100 Recession Expansion Percentage Change 36.36 18.18
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