Kaelea, Inc., has no debt outstanding and a total market value of $130,000. Earn

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Kaelea, Inc., has no debt outstanding and a total market value of $130,000. Earnings before interest and taxes, EBIT, are projected to be $9,600 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 21 percent higher. If there is a recession, then EBIT will be 34 percent lower. Kaelea is considering a $38,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,200 shares outstanding. Assume Kaelea has a market-to-book ratio of 1.0.

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

Calculate the percentage changes in ROE when the economy expands or enters a recession, assuming no taxes. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign.)

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).)

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. (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).)

Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization. Also, calculate the percentage changes in ROE for economic expansion and recession, assuming the firm goes through with the proposed recapitalization. (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).)

Requirement 1:

Explanation / Answer

Requirement I:
ROE = Net income / number of shares outstanding
Here Net income = EBIT - interest - taxes = 9600 - 0 - 0 = 9600
So ROE for each each economic scenario is calculated in the following table

Requirement II:
Current price of the share = 130,000 / 5200 = $25
After debt issue, the capital raised is used to buy back shares outstanding, so number of shares will reduce as well
Shares bought = 38000 / 25 = 1520
SO remaining shares outstanding = 5200 - 1520 = 3680
Interest paid = 38000 * 6% = 2,280
ROE = Net income / number of shares outstanding
Here Net income = EBIT - interest - taxes
So ROE for each each economic scenario is calculated in the following table

Economic Scenario EBIT Interest Taxes Net Income Number of shares ROE %Change Recession        6,336.00                       -                      -                    6,336.00                5,200.00 1.22 -34.00% Normal        9,600.00                       -                      -                    9,600.00                5,200.00 1.85 - Expansion     11,616.00                       -                      -                  11,616.00                5,200.00 2.23 21.00%

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