Charny 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% higher. If there is a recession, then EBIT will be 25% lower. Charny is considering a $65,000 debt issue with an interest rate of 6%. 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. a-1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

	ROE
Recession	%
Normal	%
Expansion	%

a-2 Calculate the percentage changes in ROE when the economy expands or enters a recession.

	% change in ROE
Recession	%
Expansion	%

Assume the firm goes through with the proposed recapitalization.

b-1. Calculate the return on equity (ROE) under each of the three economic scenarios.

	ROE
Recession	%
Normal	%
Expansion	%

b-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

	% change in ROE
Recession	%
Expansion	%

Assume the firm has a tax rate of 35%.

c-1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

	ROE
Recession	%
Normal	%
Expansion	%

c-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

	% change in ROE
Recession	%
Expansion	%

c-3. Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

	ROE
Recession	%
Normal	%
Expansion	%

c-4. Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession.

	% change in ROE
Recession	%
Expansion	%