RAK, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 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 20 percent lower. RAK is considering a $90,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 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 -20 % Expansion 12 % 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 -25.24% Expansion 15.15 % 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 % % 96 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 retum 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... 32.16.) ROE Recession Normal Expansion 96 96 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 9
