rak, Inc., has no debt outstanding and a total market value of $165,000. Earning
ID: 2758949 • Letter: R
Question
rak, Inc., has no debt outstanding and a total market value of $165,000. Earnings before interest and taxes, EBIT, are projected to be $21,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 35 percent lower. the company is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,500 shares outstanding. Ignore taxes for this problem
Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.(recession, normal, expansion)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Recession %. Expansion %)
Assume that the company goes through with recapitalization. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (recession, normal, expansion)
Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (recession%, expansion %)
Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.(recession, normal, expansion)
Calculate the percentage changes in EPS when the economy expands or enters a recession. (Recession %. Expansion %)
Assume that the company goes through with recapitalization. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (recession, normal, expansion)
Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession. (recession%, expansion %)
Explanation / Answer
1. The EPS under the three economic conditions is as follows;
2. Percentage chnage when there is an expnasion =( 4.77-3.82)/3.82 = 25%
Percentage chnage in EPS when economy is in recession = ( 2.48-3.82)/3.82 = -35%
3. When there is a debt issues, there will be an interest expense and this is tabulated below:
a.The interest expense is 7% of 60000 = 0.07*60000 =$4,200
b. The price of the share = 165000/5500 = 30. So the number of shares to be repurchased for issue of debt is 60000/30 = 2000.
Since 2000 shares are repurchased, the number of shares outstanding = 5500 -2000 = 3500
The EPS is tabulated as follows:
The % chnage in EPS in expansion = (6.3-4.8)/4.8 = 31.25%
The % change in EPS in recession = (2.7-4.8)/4.8 = -43.75%
Economy EBIT No. of shares EPS Normal 21000 5500 3.818182 Expansion 26250 5500 4.772727 Recession 13650 5500 2.481818Related Questions
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