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. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.

a-1

Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

Recession: %

Normal: %

Expansion: %

a-2

Calculate the percentage changes in ROE when the economy expands or enters a recession.

Recession: %

Expansion: %

Assume the firm goes through with the proposed recapitalization.

b-1

Calculate the return on equity (ROE) under each of the three economic scenarios.

Recession: %

Normal: %

Expansion: %

b-2

Calculate the percentage changes in ROE when the economy expands or enters a recession.

Recession %

Expansion %

c-1

Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

Recession: %

Normal: %

Expansion: %

c-3

Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

Recession:%

Normal:%

Expansion:%

c-4	Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession. Recession % Expansion %