RAK, Inc., has no debt outstanding and a total market value of $150,000. Earning
ID: 2717194 • Letter: R
Question
RAK, Inc., has no debt outstanding and a total market value of $150,000. 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 15 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $95,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 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 $150,000. 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 15 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $95,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
Explanation / Answer
(a) 1. ROE = Net profit after tax and preference dividend / Equity shareholder,s funds
Statement showing EBIT in each of the three conditions
2. Percentage change in ROE when economy expands = 27.60% - 24%
= 3.60%
Percentage change in ROE when economy enters into recession = 18% - 24%
= (6%)
(b) 1. In the absence of any information about face value of shares and repurchase price of shares it is assumed that face value of shares is $10 and they are repurchased at face valu.
If company goes through recapitalization the equity share holder's funds will be reduced to $90000, because proceeds from issue of bonds will be utilised to repurchase shares of stock.
Statement showing calculation of ROE
2. Percentage change in ROE when economy expands = 37.55% - 31.55%
= 6%
Percentage change in ROE when economy enters into recession = 21.55% - 37.55%
= (16%)
(c) 1. Statement showing EBIT in each of the three conditions
2. Percentage change in ROE when economy expands = 17.94% - 15.60%
= 2.34%
Percentage change in ROE when economy enters into recession = 11.70% - 17.94%
= (6.24%)
3Statement showing calculation of ROE
4. Percentage change in ROE when economy expands = 24.41% - 20.51%
= 3.90%
Percentage change in ROE when economy enters into recession = 14.01% - 20.51% = (6.50%)
Particulars Normal Expansion Recession EBIT/EAT $36000 $41400 $27000 Equity shareholder's fund $150000 $150000 $150000 ROE 24% 27.60% 18%Related Questions
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