Question
ROE and Leverage Suppose the firm in Problem 1 has a market-to-book ratio of 1.0. a. Calculate return on equity, ROE, under each of the
ROE and Leverage Suppose the firm in Problem 1 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. Also, calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes.
b. Repeat part (a) assuming the firm goes through with the proposed recapitalization.
c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 35 percent
Problem 1 is for reference in the question I need answered above
1.
EBIT and Leverage Castle, Inc., has no debt outstanding and a total market value of $305,000. 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 20 percent higher. If there is a recession, then EBIT will be 25 percent lower. The firm is considering a debt issue of $95,000 with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding. Ignore taxes for this problem.
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