Kaelea, Inc., has no debt outstanding and a total market value of $153,000. Earn
ID: 2646596 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $153,000. Earnings before interest and taxes, EBIT, are projected to be $9,500 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 30 percent lower. Kaelea is considering a $45,300 debt issue with an interest rate of 5 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,100 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.
Requirement 2:
Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Calculate the percentage changes in ROE for economic expansion and recession. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Assume the firm goes through with the proposed recapitalization and no taxes.Explanation / Answer
Market Value 153,000 Outstanding shares 5,100 Market Price per share 153,000 / 5,100 30 Book value per share 30 Debt 45,300 Interest 45300 * 5% 2,265 No. of shares purchased 45300 / 30 1,510 No. of outstanding shares after repurchase 5100 - 1510 3,590 Normal Expansion Recession EBIT 9,500 11,400 6,650 Interest 2,265 2,265 2,265 EBT or Net income 7,235 9,135 4,385 shareholder's equity 107,700 107,700 107,700 RoE 6.72% 8.48% 4.07% % change in RoE 26% -39%
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