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 $110,000. Earnings before interest and taxes, EBIT, are projected to be $8,800 if

Kaelea, Inc., has no debt outstanding and a total market value of $110,000. Earnings before interest and taxes, EBIT, are projected to be $8,800 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. The company is considering a $36,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 4,400 shares outstanding. Assume the company has a market-to-book ratio of 1.0.

a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued, assuming no taxes.

ROE
Recession %
Normal %
Expansion

%

b. Calculate the percentage changes in ROE when the economy expands or enters a recession, assuming no taxes.

%ROE
Recession %
Expansion %

Assume the firm goes through with the proposed recapitalization and no taxes.

c. Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization

ROE
Recession %
Normal %
Expansion %

d. Calculate the percentage changes in ROE for economic expansion and recession.

%ROE
Recession %
Expansion %

Assume the firm has a tax rate of 35 percent.

e. 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.

ROE
Recession %
Normal %
Expansion %

%ROE
Recession %
Expansion %
%ROE
Recession %
Expansion %
%ROE
Recession %
Expansion %

f. 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.

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

Step: 3

blur-text-image

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

Finance For IT Decision Makers

Authors: Michael Blackstaff

3rd Edition

1780171226, 978-1780171227

More Books

Students also viewed these Finance questions

Question

define what is meant by the term human resource management

Answered: 1 week ago