aelea, Inc., has no debt outstanding and a total market value of $129,000. Earni

Question

aelea, Inc., has no debt outstanding and a total market value of $129,000. Earnings before interest and taxes, EBIT, are projected to be $8,700 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 33 percent lower. Kaelea is considering a $42,900 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,300 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.

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).)

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.)

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).)

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).)

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).)

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).)

aelea, Inc., has no debt outstanding and a total market value of $129,000. Earnings before interest and taxes, EBIT, are projected to be $8,700 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 22 percent higher. If there is a recession, then EBIT will be 33 percent lower. Kaelea is considering a $42,900 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,300 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.

Explanation / Answer

Answered part...

Leverage

1.      a.                 Since the company has a market-to-book ratio of 1.0, the total equity of the firm is equal to the market value of equity. Using the equation for ROE:

         ROE = NI/$129,000

         ROE = 8700/129000

         The ROE for each state of the economy under the current capital structure and no taxes is:                          

Recession

Normal

Expansion

ROE

.0451

.0674

.0822

%DROE

Recession

Normal

Expansion

ROE

.0451

.0674

.0822

%DROE

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