***PLEASE CLEARLY INDICATE WHAT THE ANSWER IS FOR EACH PART. VERY CONFUSING THE
ID: 2795703 • Letter: #
Question
***PLEASE CLEARLY INDICATE WHAT THE ANSWER IS FOR EACH PART. VERY CONFUSING THE WAY THE QUESTION WAS ANSWERED WHEN I POSTED EARLIER.**
Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g., 32.)
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 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. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
c-2.
Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g., 32.)
Explanation / Answer
For Normal case, EBIT = 28,000
For expansion case, EBIT = 28,000 x (1 + 10%) = 30,800 and for recession case, EBIT = 28,000 x (1 - 25%) = 21,000
Before recap, Profits = EBIT x (1 - tax rate)
For Normal case, Profits = 28,000 x (1 - 35%) = 18,200
ROE = Profits / Equity = 18,200 / 240,000 = 7.58%
For expansion mode, ROE = 30,800 x (1 - 35%) / 240,000 = 8.34%
For recession mode, ROE = 21,000 x (1 - 35%) / 240,000 = 5.69%
% Change in ROE (Expansion) = 8.34% / 7.58% - 1 = 10.00%
% Change in ROE (Recession) = 5.69% / 7.58% - 1 = -25.00%
With $48,000 debt, Equity = 240,000 - 48,000 = $192,000
Profits = (EBIT - Interest) x (1 - tax rate), where interest = 48,000 x 4% = 1,920
Profits = (28,000 - 1,920) x (1 - 35%) = 16,952
ROE = 16,592 / 192,000 = 8.83% for normal
ROE = 18,772 / 192,000 = 9.78% for expansion
ROE = 12,402 / 192,000 = 6.46% for recession
% change in ROE = 9.78% / 8.83% - 1 = 10.74% for expansion
% change in ROE = 6.46% / 8.83% - 1 = -26.84% for recession
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