Question

Minion, Inc., has no debt outstanding and a total market value of $332,100. Earnings before interest and taxes, EBIT, are projected to be $48,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 29 percent lower. The company is considering a $170,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,100 shares outstanding. Ignore taxes for questions a) and b). Assume the company has a market-to-book ratio of 1.0 and the stock price remains constant. a-1. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) b-1. Assume the firm goes through with the proposed recapitalization. Calculate the return on equity, ROE, under each of the three economic scenarios. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) b-2. Assume the firm goes through with the proposed recapitalization. Calculate the percentage changes in ROE when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Please ONLY answer c-1 - c-4. Thank you

Answer 1

Before recapitalisation: Recession 8.11% Normal 11.42% Expansion 13.47% 2) Recession -29.00% Expansion 18.00% EBIT Less: Interest Profit before tax Less: Tax 21% Net income -Equity ROE % change in ROE Normal Recession Expansion $ 48,000 $ 34,080 $ 56,640 $ - $ - $ . $ 48,000 $ 34,080 $ 56,640 $ 10,080 $ 7,157 $ 11,894 $ 37,920 $ 26,923 $ 44,746 $332,100 $ 332,100 $ 332,100 11.42% 8.11% 13.47% -29.00% 18.00% C-3) Recession 10.81% Normal 17.59% Expansion 21.80% C-4) Recession -38.56% Expansion 23.93% =170000*7% After recapitalisation: Normal Recession Expansion EBIT $ 48,000 $ 34,080 $ 56,640 Less: Interest $ 11,900 $ 11,900 $ 11,900 Profit before tax $ 36,100 $ 22,180 $ 44,740 Less: Tax 21% $ 7,581 $ 4,658 $ 9,395 Net income $ 28,519 $ 17,522 $ 35,345 Equity $ 162,100 $ 162,100 $ 162,100 ROE L 17.59% 10.81% 21.80% % change in ROE -38.56% 23.93% =332100-170000

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