Beckett, Inc., has no debt outstanding and a total market value of $200,000. Ear
ID: 2740824 • Letter: B
Question
Beckett, 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. Beckett 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.
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).)
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.)
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).)
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 and round your final answers 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. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)
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.)
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).)
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. Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)
Beckett, 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. Beckett 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.
Explanation / Answer
a -1:
Calculate the Return O Equity (ROE) under each of the three economic scenarios before any debt issued:
Return on equity (ROE) = Net income / Shareholders equity
Details
Working note
ROE (%)
Recession
($24,000 *0.70)/$200,000
8.40
Normal
$24,000/$200,000
12.00
Expansion
($24000*1.15) /200,000
13.80
a-2:
Calculate the percentage changes in ROE when the economy expands or enters a recession:
Return on equity (ROE) = Net income / Shareholders equity
Net income = $24,000 – ($70,000 *7%)
= $24,000 -$4,900
= $19,100
Shareholders equity = $200,000 -$70,000 = $130,000
Details
ROE
Recession
-3.60
Expansion
1.80
b-1:
Calculate the return on equity (ROE) under each of the three economic scenarios:
Details
Working note
ROE
Recession
($19,100 *0.70)/$130,000
10.28
Normal
$19,100/$130,000
14.69
Expansion
($19,100*1.15) /130,000
16.90
b-2:
Calculate the percentage changes in ROE when the economy expands or enters a recession:
Return on equity (ROE) = Net income / Shareholders equity
Net income = $19,100 * (1-0.35)
= $12,415
Shareholders equity = $200,000 -$70,000 = $130,000
Details
ROE
Recession
-4.41
Expansion
2.21
c-1:
Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued:
Return on equity (ROE) = Net income / Shareholders equity
Net income = $19,100 * (1-0.35)
= $12,415
Shareholders equity = $200,000
Details
Working note
ROE
Recession
($12,415 *0.70)/$200,000
4.35
Normal
$12,415/$200,000
6.21
Expansion
($12,415*1.15) /200,000
7.14
c-2:
Calculate the percentage changes in ROE when the economy expands or enters a recession:
Details
ROE
Recession
-1.86
Expansion
0.93
c-3:
Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization:
Return on equity (ROE) = Net income / Shareholders equity
Net income = $12,415
Shareholders equity = $200,000 -$70,000 = $130,000
Details
Working note
ROE
Recession
($12,415 *0.70)/$130,000
6.69
Normal
$12,415/$130,000
9.55
Expansion
($12,415*1.15) /130,000
10.98
c-4:
Calculate the percentage changes in ROE when the economy expands or enters a recession:
Details
ROE
Recession
-2.86
Expansion
1.43
Details
Working note
ROE (%)
Recession
($24,000 *0.70)/$200,000
8.40
Normal
$24,000/$200,000
12.00
Expansion
($24000*1.15) /200,000
13.80
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