Question

Kaelea, Inc., has no debt outstanding and a total market value of $153,000. Earnings before interest and taxes, EBIT, are projected to be $9,500 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 30 percent lower. The company is considering a $45,300 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5.100 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. (Do not round intermediate calculations and enter your answers as a percent rounded 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. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g., 32.) Recession Expansion %AROE -30% 20 % 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. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) ROE Recession Normal Expansion

Part a) and c) please thank you!!

Answer 1

less: Particulars EBIT Interest EBT Tax Net income Equity ROE (net income/equity) Recession Normal $6,650 $9,500 $0 $0 $6,650 $9,500 $0 $0 $6,650 $9,500 $153,000 $153,000 4.35% 6.21% Expansion $11,400 $0 $11,400 $0 $11,400 $153,000 7.45% less: percentage change in ROE: Recession Expansion -30% 20% (4.35-6.21)/6.21 (7.45-6.21)/6.21

Affter recapitalisation: Particulars EBIT less: Interest EBT less: Tax Net income Equity ROE (net income/equity) Recession $6,650 $2,265 $4,385 $0 $4,385 $74,000 5.93% Normal Expansion $9,500 $11,400 $2,265 $2,265 $7,235 $9,135 $0 $0 $7,235 $9,135 $74,000 $74,000 9.78% 12.34%