Question

Ghost, Inc., has no debt outstanding and a total market value of $185,000. Earnings before interest and taxes, EBIT, are projected to be $29,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 40 percent lower. The company is considering a $65,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 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. |

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.) |

Answer #1

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
$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
$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
$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
$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
$200,000. Earnings before interest and taxes, EBIT, are projected
to be $24,000 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 30 percent lower. The
company is considering a $70,000 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
$220,000. 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 18 percent higher. If
there is a recession, then EBIT will be 25 percent lower. The
company is considering a $125,000 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....

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