3. 3.

ROE and leverage [LO 16.1, 16.2] Suppose the company in Problem 1 has a market-to-book ratio of 1.0 and the share price remains constant.

1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes.

2. Repeat part

(a) assuming the firm goes through with the proposed recapitalisation.

3. Repeat parts

(a) and

(b) of this problem assuming the firm has a tax rate of 30 per cent.