Kaelea, Inc., has no debt outstanding and a total market value of $82,000. Earnings before interest and taxes, EBIT, are projected to be $8,500 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 25 percent lower. Kaelea is considering a $28,200 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,100 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	%

(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.)

	%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. Enter your answer as a percentage rounded 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 round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answer 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 40 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 answer 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 calculationsNegative amounts should be indicated by a minus sign. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

	ROE
Recession	%
Normal	%
Expansion	%

	%ROE
Recession	%
Expansion	%