Question

Castle, Inc., has no debt outstanding and a total market value of $250,000. Earnings before interest and taxes, EBIT, are projected to be $42,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 30 percent lower. The firm is considering a debt issue of $100,000 with an interest rate of 8 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.

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

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.

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.

Answer 1

ERIT Intout 42000 L9sbo turoo 178 2130の 3224 1734b tgu 2.13.921 l '911-2.73 3-??14-27 1000o EBIT looo Tencer Net Income 139L0 23133 3.6833S02 9-3706