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Kaelea, Inc., has no debt outstanding and a total market value of $117,000. Earnings before interest and taxes, EBIT, are projected to be $8,300 if
Kaelea, Inc., has no debt outstanding and a total market value of $117,000. Earnings before interest and taxes, EBIT, are projected to be $8,300 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 23 percent higher. If there is a recession, then EBIT will be 32 percent lower. Kaelea is considering a $41,700 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 3,900 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. Round your answers to 2 decimal places (e.g., 32.16) .) ROE Recession Normal Expansion 1% (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.) Recession Expansion
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