Question

Assume the firm has a tax rate of 25 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 enter your answers as a percent
rounded to 2 decimal places, e.g., 32.16.) |

c-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.) |

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

c-4. |
Given the 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.) |

Answer #1

Ghost, Inc., has no debt outstanding and a total market value of
$220,100. Earnings before interest and taxes, EBIT, are projected
to be $38,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 12 percent higher. If
there is a recession, then EBIT will be 23 percent lower. The
company is considering a $120,000 debt issue with an interest rate
of 5 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$262,500. Earnings before interest and taxes, EBIT, are projected
to be $42,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 16 percent higher. If
there is a recession, then EBIT will be 27 percent lower. The
company is considering a $140,000 debt issue with an interest rate
of 5 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$273,600. Earnings before interest and taxes, EBIT, are projected
to be $43,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 17 percent higher. If
there is a recession, then EBIT will be 28 percent lower. The
company is considering a $145,000 debt issue with an interest rate
of 6 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$382,500. Earnings before interest and taxes, EBIT, are projected
to be $52,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 14 percent higher. If
there is a recession, then EBIT will be 23 percent lower. The
company is considering a $190,000 debt issue with an interest rate
of 7 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$320,000. Earnings before interest and taxes, EBIT, are projected
to be $47,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 19 percent higher. If
there is a recession, then EBIT will be 30 percent lower. The
company is considering a $165,000 debt issue with an interest rate
of 6 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$296,400. Earnings before interest and taxes, EBIT, are projected
to be $45,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 19 percent higher. If
there is a recession, then EBIT will be 30 percent lower. The
company is considering a $155,000 debt issue with an interest rate
of 8 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$450,000. Earnings before interest and taxes, EBIT, are projected
to be $57,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 16 percent higher. If
there is a recession, then EBIT will be 24 percent lower. The
company is considering a $215,000 debt issue with an interest rate
of 8 percent. The proceeds will be used to repurchase shares of...

RAK, Inc., has no debt outstanding and a total market value of
$150,000. Earnings before interest and taxes, EBIT, are projected
to be $36,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 15 percent higher. If
there is a recession, then EBIT will be 25 percent lower. RAK is
considering a $95,000 debt issue with an interest rate of 8
percent. The proceeds will be used to repurchase shares of stock....

RAK, Inc., has no debt outstanding and a total market value of
$180,000. Earnings before interest and taxes, EBIT, are projected
to be $25,000 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 20 percent lower. RAK is
considering a $60,000 debt issue with an interest rate of 5
percent. The proceeds will be used to repurchase shares of stock....

RAK, Inc., has no debt outstanding and a total market value of
$200,000. Earnings before interest and taxes, EBIT, are projected
to be $30,000 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 20 percent lower. RAK is
considering a $75,000 debt issue with an interest rate of 8
percent. The proceeds will be used to repurchase shares of stock....

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