RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2733654 • Letter: R
Question
RAK, Inc., has no debt outstanding and a total market value of $220,000. 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 10 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $135,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. RAK has a tax rate of 35 percent.
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. (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. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
I ONLY NEED PERCENTAGE CHANGES IN EPS ON A-2 EXPANSION. IS NOT 10.17% OR 10.16%
RAK, Inc., has no debt outstanding and a total market value of $220,000. 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 10 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $135,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. RAK has a tax rate of 35 percent.
Explanation / Answer
EPS under normal scenario = (EBIT - Taxes) / Shares outstanding
= (40000 - 0.35 (40000)) / 11000
= (40000 - 14000) / 11000
= 26000 / 11000
= $2.36363636.......
EPS under Expansion scenario = (EBIT - Taxes) / Shares outstanding
= ((40000 * 110%) - (40000 * 110% (0.35)) / 11000
= (44000 - 15400) / 11000
= 28600 / 11000
= $2.6
Percentage Change in EPS when economy expands
= (EPS under expansion - Normal EPS) / Normal EPS
= (2.6 - 2.363636363636.......) / 2.363636363636.......
= 0.236363636363636....... / 2.36363636363.........
= 0.1
= 10%
Percentage change on expansion = 10%
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