Percentage changes in roe when the economy expands

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Reference no: EM131825412

Castle, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 20 percent lower. The firm is considering a debt issue of $90,000 with an interest rate of 6 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 stock price remains constant.

a-1. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued.(Recession, Expansion, Normal)

a-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

Assume the firm goes through with the proposed recapitalization.

b-1. Calculate the return on equity (ROE) under each of the three economic scenarios.

b-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

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.

c-2. Calculate the percentage changes in ROE when the economy expands or enters a recession.

c-3. Calculate the return on equity (ROE) under each of the three economic scenarios assuming the firm goes through with the recapitalization.

c-4. Given the recapitalization, calculate the percentage changes in ROE when the economy expands or enters a recession.

Reference no: EM131825412

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