Kaelea, Inc., has no
debt outstanding and a total market value of $100,000. Earnings
before interest and taxes, EBIT, are projected to be $8,400 if
economic conditions are normal. If there is strong expansion in the
economy, then EBIT will be 24 percent higher. If there is a
recession, then EBIT will be 31 percent lower. The company is
considering a $35,000 debt issue with an interest rate of 6
percent. The proceeds will be used to repurchase shares of stock.
There are currently 4,000 shares outstanding. Assume the company
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, assuming no
taxes. (Do not round intermediate calculations and enter
your answers as a percent rounded to 2 decimal places, e.g.,
32.16.)
|
ROE |
|
Recession |
% |
| Normal |
% |
| Expansion |
% |
|
|
b. Calculate the percentage changes in ROE when
the economy expands or enters a recession, assuming no taxes.
(A negative answer should be indicated by a
minussign. Do not round intermediate calculations
and enter your answers as a percent rounded to the nearest whole
number, e.g., 32.)
|
%ΔROE |
|
Recession |
% |
| Expansion |
% |
|
|
Assume the firm goes through with the proposed recapitalization and
no taxes.
c. Calculate return on equity, ROE, under each of
the three economic scenarios after the recapitalization.
(Do not round intermediate calculations and enter your
answers as a percent rounded to 2 decimal places, e.g.,
32.16.)
|
ROE |
|
Recession |
% |
| Normal |
% |
| Expansion |
% |
|
|
d. Calculate the percentage changes in ROE for
economic expansion and 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.)
|
%ΔROE |
|
Recession |
% |
| Expansion |
% |
|
|
Assume the firm has a tax rate of 35 percent.
e. 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. (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.)
|
ROE |
|
Recession |
% |
| Normal |
% |
| Expansion |
% |
|
|
|
%ΔROE |
|
Recession |
% |
| Expansion |
% |
|
|
f. Calculate return on equity, ROE, under each of
the three economic scenarios after the recapitalization. Also,
calculate the percentage changes in ROE for economic expansion and
recession, assuming the firm goes through with the proposed
recapitalization. (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.)
|
ROE |
|
Recession |
% |
| Normal |
% |
| Expansion |
% |
|
|
|
%ΔROE |
|
Recession |
% |
| Expansion |
% |
|
|
jeff jeffy answered 1 year ago