RAK, Inc., has no debt outstanding and a total market value of $220,000. Earning
ID: 2737839 • 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. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
PLEASE ANSWER C-1, C-2, C-3, AND C-4
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 $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. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
PLEASE ANSWER C-1, C-2, C-3, AND C-4
Explanation / Answer
c-1. ROE before any debt is issued:
Return on equity (ROE) = Net income / Equity
Equity = $ 220,000
c-2. Percentage changes in ROE:
c-3. Firm goes through with the recapitalization:
Market price of each share = $ 220,000 / 11,000 = $ 20
Number of shares repurchased = $ 125,000 / 20 = 6,250
Book value of remaining shares = 4,750 x 20 = $ 95,000
Net income ( ignoring tax) under normal circumstances = $ (36,000 - 10,000) x 0.65 = $ 16,900
ROE = 16,900 / 95,000 x 100 = 17.79%
c-4. Percentage change in ROE:
ROE Recession 7.98% Normal 10.64% Expension 12.55%Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.