RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2732474 • Letter: R
Question
RAK, Inc., has no debt outstanding and a total market value of $220,000. 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 18 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. RAK has a tax rate of 35 percent.
Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
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. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
RAK, Inc., has no debt outstanding and a total market value of $220,000. 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 18 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $125,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. RAK has a tax rate of 35 percent.
Explanation / Answer
Without Debt Issue Particulars Normal Expansion Recession EBIT 36000 42480 27000 Less: Interest 0 0 0 Earning Before tax 36000 42480 27000 Number of shares 11000 11000 11000 EPS 3.27 3.86 2.45 Percentage Change 18% -25% With Debt issue Particulars Normal Expansion Recession EBIT 36000 42480 27000 Less: Interest 8400 8400 8400 Earning Before tax 27600 34080 18600 Number of shares 4750 4750 4750 EPS 7.58 8.94 5.68 Percentage Change 18% -25%
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