RAK, Inc., has no debt outstanding and a total market value of $150,000. Earning
ID: 2761116 • 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 $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK 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 10,000 shares outstanding. Ignore taxes for this problem. a-1 Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g, 32.16.) EPS Normal Expansion a-2 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., 3216) Percentage changes in EPS Recession 01% 0%Explanation / Answer
a-1
EPS
Recession - 28000*0.75/10000 = 2.1
Normal - 28000/10000 = 2.8
Expansion - 28000*1.2/10000 = 3.36
a-2
Percentage changes in EPS
Recession = (2.8-2.1)/2.1 = 33.33%
Expansion = (3.36-2.8)/2.8 = 20%
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