Pendergast, Inc., has no debt outstanding and a total market value of $180,000.
ID: 2762943 • Letter: P
Question
Pendergast, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergast is considering a $75,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 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. (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.(Negative amounts should be indicated by a minus sign.)
Calculate the return on equity (ROE) under each of the three economic scenarios. (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.(Negative amounts should be indicated by a minus sign. Round your 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. (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.(Negative amounts should be indicated by a minus sign.)
Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization. (Round your answers 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. Round your answers to 2 decimal places. (e.g., 32.16))
Pendergast, Inc., has no debt outstanding and a total market value of $180,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergast is considering a $75,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.
Explanation / Answer
a1)
ROE : Recession 8.94% Normal 12.78% Expansion 15.33%
a2)
% change in ROE: Recession 12.78- 8.94 = 3.84% Expansion 12.78 - 15.33 = 2.55%
the return on equity (ROE) under each of the three economic scenarios:
Interest on debt = 75000 * 7% = $5250
ROE at normal posiion = 23000 - 5250 = 17750 / 105000 = 16.90%
ROE UNDER:
RECESSION = 17750 - 30% = 12425 / 105000 = 11.83%
NORMAL = 17750 / 105000 = 16.90%
EXPANSION = 17750 + 20% = 21300 / 105000 = 20.29%
b2) the percentage changes in ROE when the economy expands or enters a recession:
% change in ROE
Recession 16.90 - 11.83 = 5.07%
Expansion 20.29 - 16.90 = 3.39%
c1)
ROE : Recession 8.94% Normal 12.78% Expansion 15.33%
c2)
% change in ROE: Recession 12.78- 8.94 = 3.84% Expansion 12.78 - 15.33 = 2.55%
c3)
ROE UNDER:
RECESSION = 17750 - 30% = 12425 / 105000 = 11.83%
NORMAL = 17750 / 105000 = 16.90%
EXPANSION = 17750 + 20% = 21300 / 105000 = 20.29%
the percentage changes in ROE when the economy expands or enters a recession:
% change in ROE
Recession 16.90 - 11.83 = 5.07%
Expansion 20.29 - 16.90 = 3.39%
b-1the return on equity (ROE) under each of the three economic scenarios:
Interest on debt = 75000 * 7% = $5250
ROE at normal posiion = 23000 - 5250 = 17750 / 105000 = 16.90%
ROE UNDER:
RECESSION = 17750 - 30% = 12425 / 105000 = 11.83%
NORMAL = 17750 / 105000 = 16.90%
EXPANSION = 17750 + 20% = 21300 / 105000 = 20.29%
b2) the percentage changes in ROE when the economy expands or enters a recession:
% change in ROE
Recession 16.90 - 11.83 = 5.07%
Expansion 20.29 - 16.90 = 3.39%
c1)
ROE : Recession 8.94% Normal 12.78% Expansion 15.33%
c2)
% change in ROE: Recession 12.78- 8.94 = 3.84% Expansion 12.78 - 15.33 = 2.55%
c3)
ROE UNDER:
RECESSION = 17750 - 30% = 12425 / 105000 = 11.83%
NORMAL = 17750 / 105000 = 16.90%
EXPANSION = 17750 + 20% = 21300 / 105000 = 20.29%
c4) Given the recapitalization,the percentage changes in ROE when the economy expands or enters a recession:
% change in ROE
Recession 16.90 - 11.83 = 5.07%
Expansion 20.29 - 16.90 = 3.39%
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