RAK, Inc, has no debt outstanding and a total market value of $240,000 Earnings
ID: 2824206 • Letter: R
Question
RAK, Inc, has no debt outstanding and a total market value of $240,000 Earnings before interest and taxes, EBIT, are projected to be $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $80,000 debt issue with an interest rate of 7 percent The proceeds will be used to repurchase shares of stock There are currently 15,000 shares outstanding Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0 a-1 Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) ROE Recession Normal Expansion 933 | % 13.33 % 15331% a-2 Calculate the percentage changes in ROE 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.) %change inROE 30.01 | % 15 % Recession Expansion Assume the firm goes through with the proposed recapitalization b-1 Calculate the return on equity (ROE) under each of the three economic scenarios. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g 32.16.) ROE Recession Normal ExpansionExplanation / Answer
Formula sheet
A B C D E F G H 2 3 Total Market Value before debt Issue $240,000 4 Number of shares outstanding 15000 5 Debt Issue $80,000 6 Interest rate 7% 7 Market to Book Ratio 1 8 9 Recession Normal Expansion 10 EBIT $22,400 $32,000 $36,800 11 12 b-1) 13 Price Per Share before issue of debt $16 14 Number of shares bought using debt 5000 15 16 Number of stocks Outstanding after the issue of debt 10000 17 18 Recession Normal Expansion 19 EBIT $22,400 $32,000 $36,800 20 Interest Expense $5,600 $5,600 $5,600 21 Income before Tax $16,800 $26,400 $31,200 22 Tax 0 0 0 23 Income after tax or net income $16,800 $26,400 $31,200 24 Shareholders Equity (Book Value) $160,000 $160,000 $160,000 25 ROE 10.50% 16.50% 19.50% 26 27 ROE 28 Recession 10.50% 29 Normal 16.50% 30 Expansion 19.50% 31 32 b-2) 33 34 Recession -36.36% 35 Expansion 18.18% 36 37 c-1) 38 39 Recession Normal Expansion 40 EBIT $22,400 $32,000 $36,800 41 Interest Expense $0 $0 $0 42 Income before Tax $22,400 $32,000 $36,800 43 Tax $7,840 $11,200 $12,880 44 Income after tax or net income $14,560 $20,800 $23,920 45 Shareholders Equity (Book Value) $240,000 $240,000 $240,000 46 ROE 6.07% 8.67% 9.97% 47 48 ROE 49 Recession 6.07% 50 Normal 8.67% 51 Expansion 9.97% 52 53 c-2) 54 55 Recession -30.00% 56 Expansion 15.00% 57 58 c-3) 59 60 Recession Normal Expansion 61 EBIT $22,400 $32,000 $36,800 62 Interest Expense $5,600 $5,600 $5,600 63 Income before Tax $16,800 $26,400 $31,200 64 Tax $5,880 $9,240 $10,920 65 Income after tax or net income $10,920 $17,160 $20,280 66 Shareholders Equity (Book Value) $160,000 $160,000 $160,000 67 ROE 6.83% 10.73% 12.68% 68 69 ROE 70 Recession 6.83% 71 Normal 10.73% 72 Expansion 12.68% 73 74 c-4) 75 76 Recession -36.36% 77 Expansion 18.18% 78Related Questions
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