RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2764008 • 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 $42,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $66,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 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.)
RAK, Inc., has no debt outstanding and a total market value of $220,000. 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 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $66,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. RAK has a tax rate of 35 percent.
Explanation / Answer
Normal Expansion Recession EBIT $42,000.00 $50,400.00 $29,400.00 Less: Tax at 35% on EBIT $14,700.00 $17,640.00 $10,290.00 Profit after tax (a) $27,300.00 $32,760.00 $19,110.00 # shares outstanding (b) 10000 10000 10000 EPS (a/b) $2.73 $3.28 $1.91 % Change in EPS 1. Recession = (2.73 - 1.91) / 2.73 = 30% 2. Expansion = (3.28 - 2.73) / 2.73 = 20% Normal Expansion Recession EBIT $42,000.00 $50,400.00 $29,400.00 Less: Interest @6% on $66000 $3,960.00 $3,960.00 $3,960.00 Profit before tax $38,040.00 $46,440.00 $25,440.00 Less: Tax at 35% on PBT $13,314.00 $16,254.00 $8,904.00 Profit after tax (a) $24,726.00 $30,186.00 $16,536.00 # shares outstanding (b) 7000 7000 7000 EPS (a/b) $3.53 $4.31 $2.36 % Change in EPS 1. Recession = (3.53 - 2.36) / 3.53 = 33.12% 2. Expansion = (4.31 - 3.53) / 3.53 = 22.08% Note - 1. EBIT Calulation under different scenarios a. Normal (given) $42,000 b. Recession(70% of Normal) $29,400 (42000*0.7) c. Expansion(120% of Normal) $50,400 (42000*1.2) # Shares outstanding after debt is issued Market Capitalization before debt issued = 220000 No of shares = 10000 Market Value per share = 220000/10000 = 22 Value of Debt issued = $66,000 No of shares reduced = 66000/22 = 3000 Hence, new outstanding shares = 10000 - 3000 = 7000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.