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Calculate the percentage changes in return on equity

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Reference no: EM131079367

RAK, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $40,000 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 20 percent lower. RAK is considering a $105,000 debt issue with an interest rate of 4 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.

a1- Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

a2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

Assume the firm goes through with the proposed recapitalization.

b1- Calculate the return on equity (ROE) under each of the three economic scenarios.

b2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

Assume the firm has a tax rate of 35 percent.

c1- Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.

c2- Calculate the percentage changes in ROE when the economy expands or enters a recession.

c3- Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

c4- Given the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

Reference no: EM131079367

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