Pendergast, Inc., has no debt outstanding and a total market value of $220,000.

Question

Pendergast, Inc., has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 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 20 percent lower. Pendergast is considering a $120,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 11,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.

Please correct the wrong answers

a-1 Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Round your answers to 2 decimal places. (e.g., 32.16)) Recession Normal Expansion ROE 9.45 0% 11.820% 13.59 % 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.) % change in ROE -20.050 % 14.94 % 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. (Round your answers to 2 decimal places. (e.g., 32.16)) Recession Normal Expansion ROE 2.24 0% 3.28 % 4.060 % b-2 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 -31.71 % 23.78 0 % Recession Expansion Assume the firm has a tax rate of 35 percent

Explanation / Answer

b-1.

c-3

c-4.

ROE Recession 11.2% Normal 16.4% Expansion 20.3%

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