Rickett, Inc. has no debt outstanding and a total market value of $173,000. Earn

Question

Rickett, Inc. has no debt outstanding and a total market value of $173,000. Earnings before interest and taxes, EBIT, are projected to be $16,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 34.5 percent higher. If there is a recession, then EBIT will be 69 percent lower. Rickett is considering a $69,000 debt issue with a 5 percent interest rate. the proceeds will be used to repurchase shares of stock. there are currently 3,000 shares outstanding. Rickett has a market-to-book ratio of 1.0. Ignore taxes for this problem.

(a) Return on equity, ROE, for the recession, normal, and expansion scenarios before any debt is issued are ______ percent, _______ percent, and _______ percent, respectively. (round to 2 decimal places) If the economy enters a recession or expands, ROE will change by _______ percent, or ________ percent, respectively.(negative amounts should be indicated by a minus sign, round to 2 decimal places)

(b) Now assume that Rickett goes through with the proposed recapitalization. Return on equity, ROE, for the recession, normal, and expansion scenarios are ________ percent, __________ percent, and __________ percent, respectively. If the economy enters a recession or expands, ROE will change by ______ percent or _______ percent, respectively. (negative amount should be indicated by a minus sign, round to 2 decimal places).

Explanation / Answer

Hi,

Please find the answers as follows;

Part A

Part B

Thanks.

Recession Normal Expansion EBIT 4960 16000 21520 Interest 0 0 0 Net Income 4960 16000 21520 ROE = Net Income/173000 (Part 1) 2.87% 9.25% 12.44% % Change in ROE (Part 2) -69.00% 0 34.50%

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