Question

In: Finance

RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest...

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 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 %  

  

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 in ROE
  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 %  
  Expansion %  

  

b-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 in ROE
  Recession %  
  Expansion %  

  

Assume the firm has a tax rate of 35 percent.

  

c-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 %  

  

c-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 in ROE
  Recession %  
  Expansion %  

  

c-3

Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

  

ROE
  Recession %  
  Normal %  
  Expansion %  

  

c-4

Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

  

% change in ROE
  Recession %  
  Expansion %  

Solutions

Expert Solution

1-

Normal

Strong

Rcession

EBIT

42000

49560

29400

Less interest

0

0

0

EBT

42000

49560

29400

less taxes-0%

0

0

0

EAT

42000

49560

29400

total equity

250000

250000

250000

ROE

EAT/total of equtiy

16.80%

19.82%

11.76%

% change in ROE =(ROE in strong/recession - ROE at normal)/ ROE at normal

18.00%

-30.00%

2-

Normal

Strong

Rcession

EBIT

42000

49560

29400

Less interest

8000

8000

8000

EBT

34000

41560

21400

less taxes-0%

0

0

0

EAT

34000

41560

21400

total equity

150000

150000

150000

ROE

EAT/total of equtiy

22.67%

27.71%

14.27%

% change in ROE =(ROE in strong/recession - ROE at normal)/ ROE at normal

22.24%

-37.06%

3-

Normal

Strong

Rcession

EBIT

42000

49560

29400

Less interest

0

0

0

EBT

42000

49560

29400

less taxes-35%

14700

17346

10290

EAT

27300

32214

19110

total equity

250000

250000

250000

ROE

EAT/total of equtiy

10.92%

12.89%

7.64%

% change in ROE =(ROE in strong/recession - ROE at normal)/ ROE at normal

18.00%

-30.00%

4-

Normal

Strong

Rcession

EBIT

42000

49560

29400

Less interest

8000

8000

8000

EBT

34000

41560

21400

less taxes-35%

11900

14546

7490

EAT

22100

27014

13910

total equity

150000

150000

150000

ROE

EAT/total of equtiy

14.73%

18.01%

9.27%

% change in ROE =(ROE in strong/recession - ROE at normal)/ ROE at normal

22.24%

-37.06%


Related Solutions

RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest...
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....
RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest...
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....
RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest...
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....
RAK, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $90,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $140,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $140,000. 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 12 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $115,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $240,000. 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 20 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $155,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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 25 percent lower. RAK is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest...
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....
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 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 20 percent lower. RAK is considering a $150,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT