Charny Inc. has no debt outstanding and a total market value of
$220,000. 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 10% higher. If there is
a recession, then EBIT will be 20% lower. Charny is considering a
$135,000 debt issue with an interest rate of 4%. The proceeds will
be used to repurchase shares of stock. There are currently 11,000
shares outstanding. Ignore taxes for questions a and b. Assume the
company has a market-to-book ratio of 1.0.
a-1. Calculate return on equity (ROE) under
each of the three economic scenarios before any debt is
issued. (Enter your answer as a percentage rounded to
2 decimal places.)
a-2. Calculate the percentage changes in
ROE when the economy expands or enters a
recession. (Do not round intermediate calculations.
Negative answers should be indicated by a minus sign. Enter the
answers as a percent rounded to the nearest whole
number.)
Assume the firm goes through with the proposed
recapitalization.
b-1. Calculate the return on equity (ROE)
under each of the three economic scenarios. (Enter
your answer as a percentage rounded to 2 decimal
places.)
b-2. Calculate the percentage changes in
ROE when the economy expands or enters a
recession. (Negative answers should be indicated by a
minus sign. Enter your answer as a percentage rounded to 2 decimal
places.)
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. (Do not round intermediate calculations. Enter
your answer as a percentage rounded to 2 decimal
places.)
c-2. Calculate the percentage changes in
ROE when the economy expands or enters a
recession. (Do not round intermediate calculations.
Negative answers should be indicated by a minus sign. Enter your
answer as a percentage rounded to 2 decimal places.)
c-3. Calculate the return on equity (ROE)
under each of the three economic scenarios assuming the firm goes
through with the recapitalization. (Do not round
intermediate calculations. Enter your answer as a percentage
rounded to 2 decimal places.)
c-4. Given the recapitalization, calculate
the percentage changes in ROE when the economy expands or enters a
recession. (Negative answers should be indicated by a
minus sign. Do not round intermediate calculations. Enter your
answer as a percentage rounded to 2 decimal places.)
Charny Inc. has no debt outstanding and a total market value of $220,000. Earnings before interest and taxes, EBIT, are
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