Money, Inc., has no debt outstanding and a total market value of $200,000. Earni

Question

Money, Inc., has no debt outstanding and a total market value of $200,000. 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 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. Money is considering a $65,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 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 and round your final 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. Do not round intermediate calculations.)

Calculate the return on equity (ROE) under each of the three economic scenarios. (Do not round intermediate calculations and round your final 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. 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 and round your final 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. Do not round intermediate calculations.)

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 and round your final 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. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

I know that the answer for a-2 in expansion is 11.92%

Money, Inc., has no debt outstanding and a total market value of $200,000. 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 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. Money is considering a $65,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0.

Explanation / Answer

Money Inc Current Situation Normal   Expansion Recession a1. Equity value          200,000        200,000          200,000 Debt (6% interest rate )                     -                     -                       -   EBIT              26,000          29,120            19,500 Less Interest Income before Tax Less Tax Net Income for Equity holders            26,000          29,120            19,500 Return on Equity (ROE) 13.00% 14.56% 9.75% a2. Details Normal   Expansion Recession % Change in ROE= 12.00% -25.00% b1. After recapitalization : Revised situation Normal   Expansion Recession Equity value          135,000        135,000          135,000 Debt (6% interest rate )            65,000          65,000            65,000 EBIT              26,000          29,120            19,500 Less Interest            (3,900)          (3,900)            (3,900) Income before Tax            22,100          25,220            15,600 Less Tax                     -                     -                       -   Net Income for Equity holders            22,100          25,220            15,600 Return on Equity (ROE) 16.37% 18.68% 11.56% b2. Details Normal   Expansion Recession % Change in ROE= 14.12% -29.41% c1. With tax before recpaitalization Normal   Expansion Recession Equity value          200,000        200,000          200,000 Debt (6% interest rate )                     -                     -                       -   EBIT              26,000          29,120            19,500 Less Interest Income before Tax            26,000          29,120            19,500 Less Tax@35%            (9,100)        (10,192)            (6,825) Net Income for Equity holders            16,900          18,928            12,675 Return on Equity (ROE) 8.45% 9.46% 6.34% c2 Details Normal   Expansion Recession % Change in ROE= 12.00% -25.00% c3 After recapitalization with TAx : Revised situation Normal   Expansion Recession Equity value          135,000        135,000          135,000 Debt (6% interest rate )            65,000          65,000            65,000 EBIT              26,000          29,120            19,500 Less Interest            (3,900)          (3,900)            (3,900) Income before Tax            22,100          25,220            15,600 Less Tax@35%            (7,735)          (8,827)            (5,460) Net Income for Equity holders            14,365          16,393            10,140 Return on Equity (ROE) 10.64% 12.14% 7.51% c4 Details Normal   Expansion Recession % Change in ROE= 14.12% -29.41%

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