Question

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 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 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.)

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
$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....

Sunrise, Inc., has no debt outstanding and a total market value
of $284,900. Earnings before interest and taxes, EBIT, are
projected to be $44,000 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 $150,000 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...

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