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19 Nov 2019

Money, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. Money is considering a $70,000 debt issue with an interest rate of 7 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 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.

Recession __%, Normal __%, Expansion __%

a-2. Calculate the percentage changes in ROE when the economy expands or enters a recession. (Assume the firm goes through with the proposed recapitalization.)

% change in ROE

Recession __%, Expansion __%

b-1. Calculate the return on equity (ROE) under each of the three economic scenarios.

Recession __%, Normal __%, Expansion __%

b-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

% 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.

Recession __%, Normal __%, Expansion __%

c-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

% 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.

Recession __%, Normal __%, Expansion __%

c-4. Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession.

% change in ROE

Recession __%, Expansion __%

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17 Oct 2019
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Related questions

RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $40,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 20 percent lower. RAK is considering a $105,000 debt issue with an interest rate of 4 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.

a1- Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

a2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

Assume the firm goes through with the proposed recapitalization.

b1- Calculate the return on equity (ROE) under each of the three economic scenarios.

b2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

Assume the firm has a tax rate of 35 percent.

c1- Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

c2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

c3- Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

c4- Given the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

RAK, Inc., has no debt outstanding and a total market value of $240,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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 25 percent lower. RAK is considering a $140,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 12,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.

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. (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 %

Kaelea, Inc., has no debt outstanding and a total market value of $74,000. Earnings before interest and taxes, EBIT, are projected to be $8,100 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 21 percent higher. If there is a recession, then EBIT will be 34 percent lower. Kaelea is considering a $27,400 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 3,700 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.

Requirement 1:
(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. Round your answers 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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)
%ΔROE
Recession %
Expansion %
Requirement 2:
Assume the firm goes through with the proposed recapitalization and no taxes.
(a)

Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
ROE
Recession %
Normal %
Expansion %
(b)

Calculate the percentage changes in ROE for economic expansion and recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
%ΔROE
Recession %
Expansion %
Requirement 3:
Assume the firm has a tax rate of 40 percent.
(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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
ROE
Recession %
Normal %
Expansion %
%ΔROE
Recession %
Expansion %
(b)

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. (Do not round intermediate calculations Negative amounts should be indicated by a minus sign. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
ROE
Recession %
Normal %
Expansion %
%ΔROE
Recession %
Expansion %

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