Beckett, Inc., has no debt outstanding and a total market value of $140,000. Ear

Question

Beckett, Inc., has no debt outstanding and a total market value of $140,000. Earnings before interest and taxes, EBIT, are projected to be $32,000 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 30 percent lower. Beckett is considering a $115,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,000 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. (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. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Enter your answers as a percent.) % 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. (Negative amounts should be ndicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).) in ROE Recession Expansion

Explanation / Answer

a-1.

Note: Since the firm has a market-to-book value of 1.0, the total equity of the firm is equal to the market value of equity. ROE = NI/E = NI/$140,000

a-2.

b-1.

b-2.

ROE Recession 16% Normal 22.86% Expansion 25.60%

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