2. value: 1.00 points Pendergast, Inc., has no debt outstanding and a total mark

Question

2.
value:
1.00 points

Pendergast, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $28,000 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. Pendergast is considering a $60,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 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. (Round your answers 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.)

  

  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. (Round your answers 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. Round your answers to 2 decimal places. (e.g., 32.16))

  

  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. (Round your answers 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.)

  

  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. (Round your answers 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))

  

  Recession %  
  Expansion %  

3.

value:
1.00 points

Rise Against Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 200,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $3.00 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

  

If EBIT is $675,000, what is the EPS for each plan? (Round your answers to 2 decimal places.(e.g., 32.16))

  

    

If EBIT is $925,000, what is the EPS for each plan? (Round your answers to 2 decimal places.(e.g., 32.16))

  

   

What is the break-even EBIT? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.)

  

$   

4.

value:
1.00 points

Rise Against Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 185,000 shares of stock outstanding. Under Plan II, there would be 135,000 shares of stock outstanding and $1.92 million in debt outstanding. The interest rate on the debt is 7 percent and there are no taxes.

  

Use M&M Proposition I to find the price per share. (Round your answer to 2 decimal places. (e.g., 32.16))

  

What is the value of the firm under each of the two proposed plans? (Do not round intermediate calculations and round your final answers to the nearest whole dollar amount. (e.g., 32))

  

Rise Against Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 200,000 shares of stock outstanding. Under Plan II, there would be 150,000 shares of stock outstanding and $3.00 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.

Explanation / Answer

Answer: a-1 Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued:

Since the firm has a market to book value of 1.0, the total equity of the firm is equal to the market value of equity.

ROE = NI/E = NI/$150,000

The ROE for each state of the economy under the current capital structure and no taxes is:

Answer a-2

Sensitivity Analysis: Normal to Recession

%?ROE = (0.14-0.1867)/0.1867 =-25.01%

Sensitivity Analysis: Normal to Expansion

%?ROE = (0.224-0.1867)/0.1867 =19.98%

Answer:b-1

Repeat part (a) assuming the firm goes through with the recapitalization.

Assuming no taxes, interest on debt of 7%.

If the firm goes forward with recapitalization, the new equity value will be:

Equity = $150,000-$60,000 or $90,000 [due to reduction of shares outstanding]

So, the ROE for each state of the economy is:

ROE = NI/$90,000

Answer:b-2

Sensitivity Analysis: Normal to Recession

%?ROE = (0.1867-0.2644)/0.2644 =-29.39%

Sensitivity Analysis: Normal to Expansion

%?ROE =(0.3267-0.2644)/0.2644 =23.56%

Answer:c-1

Repeat parts (a) and (b) of this problem considering the fact that the Company has a 35% tax rate.

Answer:c-2

Sensitivity Analysis: Normal to Recession

%?ROE = (0.091-0.1213)/0.1213 =-24.98%

Sensitivity Analysis: Normal to Expansion

%?ROE = (0.1456-0.1213)/0.1213 =20.03%

Answer:c-3

Answer:c-4

Sensitivity Analysis: Normal to Recession

%?ROE = (0.1213-0.1719)/0.1719 =-29.44%

Sensitivity Analysis: Normal to Expansion

%?ROE = (0.2123-0.1719)/0.1719 =23.50%

Answer: 3 (a) If EBIT is $675,000, what is the EPS for each plan:

Answer:3 (b) If EBIT is $925,000, what is the EPS for each plan:

Answer:3 (c) calculation of break-even EBIT:

(EBIT* - I1) (1

Recession Normal Expansion ROE $21000/$150000 $28000/$150000 $33600/$150000 ROE 0.14 0.1867 0.224 25% lower 20% higher

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