RAK, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $25,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 10 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $60,000 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. RAK has a tax rate of 35 percent.
1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.
Recession: $
Normal: $
Expansion: $
2. Calculate the percentage changes in EPS when the economy expands or enters a recession.
Recession: %
Expansion: %
3. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.
Recession: $
Normal: $
Expansion: $
4. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.
Recession: %
Expansion: %