In: Finance
Castle, Inc., has no debt outstanding and a total market value
of $200,000. Earnings before interest and taxes, EBIT, are
projected to be $30,000 if economic conditions are normal. If there
is strong expansion in the economy, then EBIT will be 18 percent
higher. If there is a recession, then EBIT will be 20 percent
lower. The firm is considering a debt issue of $75,000 with an
interest rate of 8 percent. The proceeds will be used to repurchase
shares of stock. There are currently 8,000 shares outstanding.
Ignore taxes for questions a and b. Assume the stock price remains
constant.
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. (A negative answer
should be indicated by a minus sign. Do not round intermediate
calculations. Enter your answers as a percent rounded to the
nearest whole number, e.g., 32.)
% 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. (A negative answer
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. (A negative
answer should be indicated by a minus sign. Do not round
intermediate calculations. Enter your answers as a percent rounded
to the nearest whole number, e.g., 32.)
% 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.
(A negative answer 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 | % | |