FINANCE 530 – RAK, Inc., has no debt outstanding and a total

FINANCE 530 – RAK, Inc., has no debt outstanding and a total market value

Subject: Business    / Finance
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 a 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.

a. Calculate earnings per share under each of the threeeconomic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enter a recession.

b. Repeat part (a) assuming that the company goes through with recapitalization? What do you observe?