Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 if

Kaelea, Inc., has no debt outstanding and a total market value of $125,000. Earnings before interest and taxes, EBIT, are projected to be $10,400 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 35 percent lower. Kaelea is considering a $42,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 6,250 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.

Requirement 1:
(a)

Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued, assuming no taxes. (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

ROE
Recession %
Normal %
Expansion %

(b)

Calculate the percentage changes in ROE when the economy expands or enters a recession, assuming no taxes. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

%ROE
Recession %
Expansion %
Requirement 2:
Assume the firm goes through with the proposed recapitalization and no taxes.

(a)

Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

ROE
Recession %
Normal %
Expansion %

(b)

Calculate the percentage changes in ROE for economic expansion and recession. (Do not roundintermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

%ROE
Recession %
Expansion %

Requirement 3:
Assume the firm has a tax rate of 35 percent.

(a)

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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

ROE
Recession %
Normal %
Expansion %

%ROE
Recession %
Expansion %

(b)

Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization. Also, calculate the percentage changes in ROE for economic expansion and recession, assuming the firm goes through with the proposed recapitalization. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

ROE
Recession %
Normal %
Expansion %

%ROE
Recession %
Expansion %

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Inflation Growth And International Finance

Authors: Alec Cairncross

1st Edition

113865308X, 978-1138653085

More Books

Students also viewed these Finance questions

Question

What steps can senior managers take to develop global managers?

Answered: 1 week ago

Question

find all matrices A (a) A = 13 (b) A + A = 213

Answered: 1 week ago

Question

Identify the elements that make up the employee reward package.

Answered: 1 week ago

Question

Understand the purpose, value and drawbacks of the interview.

Answered: 1 week ago