RAK, Inc., has no debt outstanding and a total market value of $200,000. Earning
ID: 2711844 • Letter: R
Question
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. There are currently 8,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
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.)
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.)
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.)
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.)
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.)
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.)
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.)
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))
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. There are currently 8,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
Explanation / Answer
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.)
Recession
Equity = 200000
Net Income = (EBIT*(1-30%)-interest)*(1-tax rate)
Net Income = (24000*(1-30%)-0)*(1-0%)
Net Income = 16800
ROE = Net income/Equity
ROE = 16800/200000
ROE = 8.40%
Normal
Equity = 200000
Net Income = (EBIT-interest)*(1-tax rate)
Net Income = (24000-0)*(1-0%)
Net Income = 24000
ROE = Net income/Equity
ROE = 24000/200000
ROE = 12%
Expansion
Equity = 200000
Net Income = (EBIT*(1+15%)-interest)*(1-tax rate)
Net Income = (24000*(1+15%)-0)*(1-0%)
Net Income = 27600
ROE = Net income/Equity
ROE = 27600/200000
ROE = 13.80%
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 = (8.40% - 12%)/12% = -30%
Expansion = (13.80% - 12%)/12% = 15%
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.)
Recession
Equity = 200000 -70000 = 130000
Net Income = (EBIT*(1-30%)-interest)*(1-tax rate)
Net Income = (24000*(1-30%)-70000*7%)*(1-0%)
Net Income = 11900
ROE = Net income/Equity
ROE = 11900/130000
ROE = 9.15%
Normal
Equity = 200000 -70000 = 130000
Net Income = (EBIT-interest)*(1-tax rate)
Net Income = (24000-70000*7%)*(1-0%)
Net Income = 19100
ROE = Net income/Equity
ROE = 19100/130000
ROE = 14.69%
Expansion
Equity = 200000 -70000 = 130000
Net Income = (EBIT*(1+15%)-interest)*(1-tax rate)
Net Income = (24000*(1+15%)-70000*7%)*(1-0%)
Net Income = 22700
ROE = Net income/Equity
ROE = 22700/130000
ROE = 17.46%
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 = (9.15% - 14.69%)/14.69% = -37.71%
Expansion =(17.46% - 14.69%)/14.69% = 18.86%
a-1Calculate 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.)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.