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.

  

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	$
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 %     Expansion %    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 $      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 %   Expansion %

Answer 1

a 1		EPS
	Recession	$          2.94
	Normal	$          4.20
	Expansion	$          4.96
	Earning per share =	net income available for shareholders
		No of shares outstanding
	Recession =	29,400/10,000
	Normal =	42,000/10,000
	Expansion =	49,560/10,000
a 2	Percentage changes in EPS
	Recession	-30.00%
	Expansion	18.00%
b 1		EPS
	Recession	$          3.97
	Normal	$          5.67
	Expansion	$          6.69
	Value of share =	250,000/10,000
		$ 25 per share
	Fund raised through debt issue =	$ 100,000.00
	No.of shares bought back	4,000
	No.of shares outstanding =	10,000-4,000
		6,000 nos
	EBIT at normal condition =	42,000-8,000
	=	34,000
	Recession =	23,800/6,000
	Normal =	34,000/6,000
	Expansion =	40,120/6,000
a 2	Percentage changes in EPS
	Recession	-30.00%
	Expansion	18.00%