RAK, Inc., has no debt outstanding and a total market value of $250,000. Earning
ID: 2788022 • Letter: R
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 $40,000 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 20 percent lower. RAK is considering a $105,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for this problem a-1 Calculate eanings 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 Normal Expansion 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 -20 % Expansion 20 % 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 "O" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) EPS Recession Normal Expansion 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 -22.35 % Expansion 22.35 %Explanation / Answer
Requirement a-1: Calculation of Earnings per share before any debt is issued: Particulars Recession Normal Expansion EBIT 32000 40000 48000 Number of shares 10000 10000 10000 EPS 3.2 4 4.8 Requirement a-2: Calculation of percentage changes in EPS when economy expands or enters into recession: Particulars Recession Expansion EPS 3.2 4.8 Normal EPS 4 4 Change in EPS -0.8 0.8 Percentage change in EPS -20 20 Requirement b-1: Calculation of EPS after recapitalisation: Particulars Recession Normal Expansion EBIT 32000 40000 48000 Less: Interest (105000*4%) 4200 4200 4200 EBT 27800 35800 43800 Number of shares 10000 10000 10000 EPS 2.78 3.58 4.38 Requirement b-2: Calculation of percentage changes in EPS when economy expands or enters into recession: Particulars Recession Expansion EPS 2.78 4.38 Normal EPS 3.58 3.58 Change in EPS -0.8 0.8 Percentage change in EPS -22.35 22.35
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