RAK, Inc., has no debt outstanding and a total market value of $250,000. Earning

Question

RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $42,000 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 30 percent lower. RAK is considering a $100,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem.

b-1: 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.)

b-2: Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession

Explanation / Answer

Normal condition Expansion recession value of firm 250000 EBIT 42000 49560 29400 no of shares outstanding 10000 Interest 8000 8000 8000 share price per unit 25 Earnings available to equity share holder 34000 41560 21400 no of equity share left after repurchase 6000 6000 6000 share repurchased 100000 EPS 5.67 6.93 3.57 market value of share left 150000 change in EPS 22.24% -37.06% no fof share outstanding after reprchase 6000

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