Problem ROE and Leverage

Money, Inc., has no debt outstanding and a total market value of $240000 Earnings before interest and taxes, EBIT, are projected to be $28,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 10 percent higher If there is a recession, then EBIT will be 25 percent lower Money is considering a $48u000 debt issue with an interest rate of 4 percent The proceeds will be used to repurchase shares of stock. There are currently 20.000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1 0.

a-I. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

ROE

Recession            875 %

Normal               11-67 %

Expansion           1283 %

a-2. Calculate the percentage changes in ROE when the economy expands or enters a recession (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations.)

% change in ROE

Recession                          -25 %

Expansion                           10 %

Assume the firm goes through with the proposed recapitalization

b-1. Calculate the return on equity (ROE) under each of the three economic scenarios. (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

ROE

Recession            %

Normal                 %

Expansion           %

b-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

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

% change in ROE

Recession                            -26.84 %

Expansion                           10.74 %

Assume the firm has a tax rate of 35 percent.

c-1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

ROE

Recession                            5.69 %

Normal                               7.58%

Expansion                           8.34 %

c-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

(Negative amounts should be indicated by a minus sign. Do not round intermediate calculations.)

% change in ROE

Recession                            -25 %

Expansion                           10 %

c-3. Calculate the return on equity (ROE) under each of the three economic scenarios assuming me firm goes through with the recapitalization. (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))

ROE

Recession                            %

Normal                                 %

Expansion                           %