Kaelea, Inc., has no debt outstanding and a total market value of $74,000. Earni
ID: 2769209 • Letter: K
Question
Kaelea, Inc., has no debt outstanding and a total market value of $74,000. Earnings before interest and taxes, EBIT, are projected to be $8,100 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 $27,400 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 3,700 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
Answer: Requirement 1:(a) &(b) Since the Kaelea has a market-to-book ratio of 1.0, the total equity of the firm is equal to the market value of equity. Using the equation for ROE:
ROE = NI/$74,000
The ROE for each state of the economy under the current capital structure and no taxes is:
Answer: Requirement 2: If the company undertakes the proposed recapitalization, the new equity value will be:
Equity = $74,000 – 27,400
Equity = $46,600
So, the ROE for each state of the economy is:
ROE = NI/$46600
Answer: Requirement 3: If there are corporate taxes and the company maintains its current capital structure, the ROE is:
Particulars Recession Normal Expansion EBIT 5346 8100 9801 Equity 74000 74000 74000 ROE 7.22% 10.95% 13.24% % change in ROE -34.06% 20.91%Related Questions
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