Question

Ghost, Inc., has no debt outstanding and a total market value of $273,600. Earnings before interest and taxes, EBIT, are projected to be $43,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 17 percent higher. If there is a recession, then EBIT will be 28 percent lower. The company is considering a $145,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,600 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0 and the stock price remains constant.

	a-1. Recession ROE 11.32 % Normal ROE 15.72 % Expansion ROE 18.39 % a-2. Recession percentage change in ROE -28.00 % Expansion percentage change in ROE 17.00 % b-1. Recession ROE 17.31 % Normal ROE 26.67 % Expansion ROE 32.36 % b-2. Recession percentage change in ROE -35.10 % Expansion percentage change in ROE 21.31 %

Assume the firm has a tax rate of 21 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 and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Assume the firm has a tax rate of 21 percent.  

c-2. Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

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 and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

c-4. Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1