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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

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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.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

ROE
Recession%
Normal%
Expansion%
a-2

Calculate the percentage changes in ROE 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.)

% change in ROE
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.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

ROE
Recession%
Normal%
Expansion%
b-2

Calculate the percentage changes in ROE 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.)

% change in ROE
Recession%
Expansion%
Assume the firm has a tax rate of 35 percent.
c-1

Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

ROE
Recession%
Normal%
Expansion%
c-2

Calculate the percentage changes in ROE 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.)

% change in ROE
Recession%
Expansion%
c-3

Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.(Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

ROE
Recession%
Normal%
Expansion%
c-4

Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession.(Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

% change in ROE
Recession%
Expansion%

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