RAK, Inc., has no debt outstanding and a total market value of $240, 000. Earnin

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 $26, 000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $150, 000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 15. 000 shares outstanding. Ignore taxes for this problem. a-1 Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. a-2 Calculate the percentage changes in EPS when the economy expands or enters a recession. b-1 Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. b-2 Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.

Explanation / Answer

Shares price 16 = 240000/15000 Recession Normal Expansion EBIT 192000 240000 283200 Shares 15000 15000 15000 EPS 12.8 16 18.88 EPSPercentage change -20.00% 18.00% Shares Buy back 9375 =150000/16 Recession Normal Expansion EBIT 192000 240000 283200 Interest 12000 12000 12000 EBIT-Interest 180000.00 228000.00 271200.00 Shares 5625 5625 5625 EPS 32 40.53333 48.21333333 EPSPercentage change -21.05% 18.95%

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