Answers are provided in brackets, please provide solutions as to how answers are derived. Thanks.

Control Inc., has no debt outstanding and a total market value of $100,000. EBIT is projected to be $6,000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 30% higher. If there is a recession, then EBIT will be 60% lower. The firm is considering a $40,000 debt issue with 5% interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares outstanding. Ignore taxes for this problem.Suppose the firm has a market-to-book ratio of 1 (i.e., the book value of equity - which is what you use when calculating ROE - is the same as the market value of equity) Recall, ROE = NI / Equity.

a. Calculate 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. (Ans. Normal 0.06, Boom 0.078, Bust 0.024)

b. Repeat part (a) assuming the firm goes through with the proposed capitalization. (Ans. Normal 0.0667, Boom 0.0967, Bust 0.0067