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ROE and Leverage Suppose the company in Problem 1 has a market-to-book ratio of 1.0. a....

ROE and Leverage
Suppose the company in Problem 1 has a market-to-book ratio of 1.0.
a. Calculate return on equity, ROE, under each of the three economic scenarios before any
debt is issued. Also calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes.
b. Repeat part (a) assuming the firm goes through with the proposed recapitalization.
c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 21 percent.

Please show all the steps and don't round off calculations.


Problem 1 :
Sunrise, Inc., has no debt outstanding and a total market value of 245000. Earnings before interest and taxes, EBIT, are projected to be $19,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent higher. If there is a recession, then EBIT will be 40 percent lower. The company is considering a $58800 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios.

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jeff jeffy answered 4 days ago
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