RAK, Inc. has no debt outstanding and a total market value of $220,000 Earnings
ID: 2761452 • 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 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., 32.76.) 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.)Explanation / Answer
1) calculate EPS in NORMAL EBIT/No of outstanding shares= 40000/11000= 3.64
EXPANSION (10% Over EBIT) 44000/11000 = 4.00
RECESSION(20% lower over EBIT) 32000/11000=2.91
2) Percentage of change in EPS= EXpansion = (EPS of EXPansion-EPs of Normal / EPS OF NOrmal*100)
4.00-3.64/3.64*100=9.89%
RECESSION(EPS of Normal-EPS of Recession/ EPS of NOrmal/100)
3.64-2.91/3.64*100=20.05%
When recapitalisation took place with Debt ammounting to $ 135000 % 4% intrest the new EBT would be
NORMAL= $ 40000-5400= 34600 (135000*4/100=$ 5400)
EXPANSSION = $ 44000-$5400=$ 38600
RECESSION= $ 32000-$ 5400=$ 26600
after recapitalisation the outstanding shares would be=11000-6750=4250
Note : NEW Shares calculation= Market value of the company is $ 220000
and the outstanding shares are 11000
so the market value of each share =220000/11000=20
so when we use the debt amount of $ 135000 to purchase company shares at market price the total no of shares can be purchased is $ 135000/20=6750
So the new EPS = NORMAL = EBT/No of outstandin shares =34600/4250=8.14
EXPANSION= 38600/4250= 9.08
RECESSION= 26600/4250=6.26
The percentage change in EPS=
EXPANSION= (EPS of Expansion-EPS of Normal/EPS of Normal*100)
(9.08-8.14/8.14*100) =11.55%
Recession =(EPS of Normal-EPS of Recession/EPS of Normal*100)
=(8.14-6.26/8.14*100)=23.09%
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