RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...

RAK, Inc., has no debt outstanding and a total market value of $200,000. 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 25 percent lower. RAK is considering a $65,000 debt issue with an interest rate of 6 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	%

Solutions

Expert Solution

	Given,
	Market Value of RAK Inc = $200000
	No of Shares Outstanding = 10000
	Normal EBIT = $26000
	EBIT at Expansion = Normal EBIT + 12%
	=$26000 + 12%
	=$29120
	EBIT at Recession = Normal EBIT - 25%
	=$26000 - 25%
	=$19500
	Value of Debt Issue = $65000
	Interest Rate of Debt = 6%

	Therefore, we need first calculate following

	Market Price Per Share
	= Market Value of RAK Inc / No of Shares Outstanding
	= $200000 / 10000
	= $20

	Interest on Debt = Value of Debt * Interest Rate of Debt
	= $65000 * 6%
	= $3900

	No of Shares Repurchased
	= Value of Debt used for Repurchase of Shares / Market Price Per Share
	= $65000 / $20
	= 3250 Shares

	No of Shares Outstanding after recapitalization
	= No of Shares Outstanding before recapitalization - No of Shares repurchased
	= 10000 - 3250
	= 6750

	Now,

a) 1	Calculation of EPS before any Debt is Issued
	Particulars	Recession	Normal	Expansion
A.	EBIT	19500	26000	29120
B.	No of Shares Outstanding	10000	10000	10000
C.	EPS (A / B)	1.95	2.60	2.91

a) 2	Calculation of % Changes in EPS
	% Changes in EPS for Recession
	= [(EPS of Recession - EPS of Normal) / EPS of Normal]*100
	=[(1.95 - 2.60) / 2.60] *100
	= -0.65 / 2.60 *100
	= - 25%

	% Changes in EPS for Expansion
	= [(EPS of Expansion - EPS of Normal) / EPS of Normal]*100
	=[(2.91 - 2.60) / 2.60] *100
	= 0.31 / 2.60 *100
	= 11.92%

b) 1	Calculation of EPS after any Debt is Issued
	Particulars	Recession	Normal	Expansion
A.	EBIT	19500	26000	29120
B.	Interest	3900	3900	3900
C.	Earnings After Interest (A-B)	15600	22100	25220
D.	No of Shares Outstanding	6750	6750	6750
E.	EPS (C / D)	2.31	3.27	3.74

b) 2	Calculation of % Changes in EPS
	% Changes in EPS for Recession
	= [(EPS of Recession - EPS of Normal) / EPS of Normal]*100
	=[(2.31 - 3.27) / 3.27] *100
	= -0.96 / 3.27 *100
	= - 29.36%

	% Changes in EPS for Expansion
	= [(EPS of Expansion - EPS of Normal) / EPS of Normal]*100
	=[(3.74 - 3.27) / 3.27] *100
	= 0.47 / 3.27 *100
	= 14.37%				jeff jeffy answered 1 year ago Next > < Previous Related Solutions RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest... RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 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 $70,000 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 $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. 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RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...

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