RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2764014 • 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. Ignore taxes for this problem. a-1 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.) EPS Recession $ 2.45 Normal $ 3.27 Expansion $ 3.86 a-2 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.) Percentage changes in EPS Recession % Expansion 18.04 % 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.) EPS Recession $ 3.58 Normal $ 5.47 Expansion $ 6.84 b-2 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.) Percentage changes in EPS Recession % Expansion 25.05 %
Explanation / Answer
Answer:a-1
Answer:a-2 % EPS going from Normal to Expansion:=(3.86-3.27)/3.27=18.04%
% EPS going from Normal to Recession:=(2.45-3.27)/3.27=-25.08%
Answer:b-1 If the market value of the firm is $220,000 with 11000 shares outstanding, then the value of one share of stock is: $220,000/11000 = $20/share. If $125,000 worth of debt is raised to retire stock, then you will be buying back $125000/$20 or 6250 shares. So, after recapitalization there will be 11000 -6250 or 4750 shares outstanding. EBIT will be reduced by the amount of the interest on $125000 in debt or $125000 x .08 = $10,000.
Answer:b-2
% EPS going from Normal to Expansion:=(8.94-7.58)/7.58=17.94%
% EPS going from Normal to Recession:=(5.68-7.58)/7.58=-25.07%
Particulars Expansion Normal Recession EBIT 42480 36000 27000 No. of shares outstanding 11000 11000 11000 EPS 3.86 3.27 2.45Related Questions
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