Kaelea, Inc., has no debt outstanding and a total market value of $82.000. Earmi

ID: 2614238 • Letter: K

Question

Kaelea, Inc., has no debt outstanding and a total market value of $82.000. Earmings before interest and taxes, EBIT, are projected to be $8,500 if economic conditions are normal If there is strong expansion in the economy, then EBIT will be 20 percent higher If there is a recession, then EBIT will be 25 percent lower. The company is considering a $28,200 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are ourrently 4,100 shares outstanding. Assume the company has a market to- book ratio of 1.0 a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued, assuming no taxes. (Do not round intermediate calculations and enter your answers as a percet rounded to 2 decimal places, eg, 32%) ROE Normal b. Calculate the percentage changes in ROE when the economy expands or enters a recession, assuming no taxes. (A negative answer should be indicated by a minus sign, Do not round intermediate calculations and enter your answers as a percent rounded to the nearest whole number, e.g. 32.) Assume the firm goes through with the proposed recapitalization and no taxes. c. Caloulate return on equity, ROE, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g, 32.16.) d. Calculate the percentage changes in RDE for economic expansion and 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 Assume the firm has a tax rate of 40 percent e. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in ROE for economic expansion and 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,.g 32.16.) ROE

Explanation / Answer

ROE = Earnings for Equity/Equity

Recession =

EBIT = 8500*75% = 6,375

EQUITY = 82,000

Book Value is same as market value as given in question

ROE = 6375/82000 = 7.77%

Normal = 8500/82000 = 10.37%

Expansion = 8500*120%/82000

=12.44%

B. % change in ROE

Recession = (7.77-10.37)/10.37 =- 25.07%

Expansion = (12.44-10.37)/10.37 = 19.96%

Recession

Normal

Expansion

EBIT

6375

8500

10200

Less: Interest 28200*7%

1974

EFE

4401

6526

8226

Equity 82000-28200

53800

ROE

8.18%

12.13%

15.29%

d. % change in ROE:

Recession = (8.18-12.13)/12.13 = -32.56%

Expansion = (15.29-12.13)/12.13 = 26.05%

e.Tax Rate of 40%

Recession = 6375*0.6/82000 = 4.66%

Normal = 8500*.6/82000 = 6.22%

Expansion = 10200*0.6/82000 = 7.46%

% change:

Recession = -25.08%

Expansion = 19.94%