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. There are currently 8,000 shares outstanding. Ignore taxes for questions a and b. Assume the company has a market-to-book ratio of 1.0. |
a-1 |
Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
ROE | ||
Recession | % | |
Normal | % | |
Expansion | % | |
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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
% change in ROE | ||
Recession | % | |
Expansion | % | |
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. Enter your answers as a percent rounded 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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
% change in ROE | ||
Recession | % | |
Expansion | % | |
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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
ROE | ||
Recession | % | |
Normal | % | |
Expansion | % | |
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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
% change in ROE | ||
Recession | % | |
Expansion | % | |
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. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) |
ROE | ||
Recession | % | |
Normal | % | |
Expansion | % | |
c-4 |
Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16)) |
% change in ROE | ||
Recession | % | |
Expansion | % | |
a-1.
ROE | |
Recession | 12 % |
Normal | 15 % |
Expansion | 17.7 % |
a-2.
% change in ROE | |
Recession | - 20 % |
Expansion | 18 % |
b-1.
ROE | |
Recession | 14.4 % |
Normal | 19.2 % |
Expansion | 23.52 % |
b-2.
% change in ROE | |
Recession | - 25 % |
Expansion | 22.5 % |
c-1.
ROE | |
Recession | 7.8 % |
Normal | 9.75 % |
Expansion | 11.51 % |
c-2.
% change in ROE | |
Recession | - 20 % |
Expansion | 18.05 % |
c-3.
ROE | |
Recession | 9.36 % |
Normal | 12.48 % |
Expansion | 15.29 % |
c-4.
% change in ROE | |
Recession | - 25 % |
Expansion | 22.52 % |
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