Money, Inc., has no debt outstanding and a total market value of $240,000. Earni

Question

Money, Inc., has no debt outstanding and a total market value of $240,000. 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 10 percent higher. If there is a recession, then EBIT will be 25 percent lower. Money is considering a $48,000 debt issue with an interest rate of 4 percent. The proceeds will be used to repurchase shares of stock. There are currently 20,000 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. (Do not round intermediate calculations and round your final 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. Do not round intermediate calculations.) % change in ROE 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. (Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) ROE Recession Normal Expansion b-2. Calculate the percentage changes i n ROE when the economy expands or enters a recession (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16)) % chanc in ROE Recession Expansion

Explanation / Answer

a.1) ROE before any debt is being issued.

12.83%

a.2)

b.1)

b.2)

c.1)

c.2.)

c.3)

c.4)

Serial number Particulars Recession Normal Expansion A EBIT 21000 28000 30800 C Earnings before tax 21000 28000 30800 D Shareholder's Equity 240000 240000 240000 E Return on equity = C/D 8.75% 11.67%

12.83%

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