RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2762707 • 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 $36,000 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 25 percent lower. RAK is considering a $125,000 debt issue with an interest rate of 8 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.
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.)
It was previously answered 3 times, but those answers were wrong!
RAK, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $36,000 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 25 percent lower. RAK is considering a $125,000 debt issue with an interest rate of 8 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
A1
EPS normal = EBIT*(1-tax rate)/ shares outstanding
=36000*(1-0.35)/11000
=2.13
EPS recession = EBIT*(1+recession decrease rate)*(1-tax rate)/ shares outstanding
=36000*(1-0.25)*(1-0.35)/11000
=1.60
EPS Expansion = EBIT*(1+expansion increase rate)*(1-tax rate)/ shares outstanding
=36000*(1+0.18)*(1-0.35)/11000
=2.51
A2
Expansion percentage change = (EPS Expansion- EPS normal)*100/ EPS normal
=(2.51-2.13)*100/2.13 = 17.84%
recession percentage change = (EPS recession - EPS normal)*100/ EPS normal
=(1.60-2.13)*100/2.13 = -24.88%
B1
Price per share = MV/shares outstanding
=220000/11000 = 20
Total shares repurchased = debt/share price = 125000/20 = 6250
Total remaining shares = current shares- shares repurchased = 11000-6250 = 4750
EPS normal = (EBIT-debt*interest rate)*(1-tax rate)/ shares outstanding
=(36000-125000*.08)*(1-0.35)/4750
=3.56
EPS recession = (EBIT*(1+recession decrease rate) -debt*interest rate )*(1-tax rate)/ shares outstanding
=(36000*(1-0.25)- 125000*.08)*(1-0.35)/4750
=2.33
EPS Expansion =( EBIT*(1+expansion increase rate) -debt*interest rate )*(1-tax rate)/ shares outstanding
=(36000*(1+0.18)- 125000*.08)*(1-0.35)/4750
=4.44
B2
Expansion percentage change = (EPS Expansion- EPS normal)*100/ EPS normal
=(4.44-3.56)*100/3.56 = 24.72%
recession percentage change = (EPS recession - EPS normal)*100/ EPS normal
=(2.33-3.56)*100/3.56 = -34.55%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.