RAK, Inc., has no debt outstanding and a total market value of $140,000. Earning

ID: 2763962 • Letter: R

Question

RAK, Inc., has no debt outstanding and a total market value of $140,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 30 percent lower. RAK is considering a $115,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,000 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

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.)

Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization. (Leave no cells blank - be certain to enter "0" wherever required. 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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

b-1

EPS Recession $ Normal $ Expansion $

b-2

Percentage changes in EPS Recession % Expansion %

Explanation / Answer

Market value of company = $140,000

Number of outstanding share = 7,000

Price per share = $140,000 / 7,000

= $20

Price per share of company is $20.

Current EBIT = $32,000

EBIT in case of Expansion = $32,000 × (1+12%)

= $35,840

EBIT in case of recession = $32,000 × (1 - 30%)

= $22,400

Company planning to raise 115,000 as debt to repurchase stock. Interest rate on debt is 6%.

Total interest on debt = $115,000 × 6%

= $6,900

Total number of share repurchase from $115,000 at current price of $20 per share is calculated below:

Number of share repurchase = $115,000 / $20

= $5,750

After repurchase number of share remains = 7,000 – 5,750

= 1,250

Now earnings per share in normal case is calculated below:

EPS = ($32,000 - $6,900) / 1,250

= $20.08

Earning in case of normal economy is $20.08.

Earnings per share in expansion case is calculated below:

EPS = ($35,840 - $6,900) / 1,250

= $23.152

Earning in case of expansion economy is $20.08.

Earnings per share in recession case is calculated below:

EPS = ($22,400 - $6,900) / 1,250

= $12.4

Earning in case of recession economy is $12.40.

Percentage change in EPS from normal economy to expansion economy is calculated below:

= ($23.152 – $20.08) / $20.08

=15.30%

Hence, Percentage change in EPS from normal economy to expansion economy is 15.30%

Percentage change in EPS from normal economy to recession economy is calculated below:

= ($12.40 – $20.08) / $20.08

= -38.25%

Hence, Percentage change in EPS from normal economy to recession economy is -38.25%

Navigate

RAK, Inc. has no debt outstanding and a total market value of $220,000 Earnings

RAK, Inc., has no debt outstanding and a total market value of $140,000. Earning

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.

RAK, Inc., has no debt outstanding and a total market value of $140,000. Earning

Question

Explanation / Answer

Related Questions

Navigate