Problem $16-3$ ROE and Leverage

Fujita, Incorporated, has no debt outstanding and a total market value of $$284,900.$

Earnings before interest and taxes, EBIT, are projected to be $$44,000$ 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 $29$ percent lower. The

company is considering a $$150,000$ debt issue with an interest rate of $7$ percent. The

proceeds will be used to repurchase shares of stock. There are currently $7,700$ shares

outstanding. Ignore taxes for questions $($a$)$ and $($b$).$ Assume the company has a market$-$

to$-$book ratio of $1\mathrm{.}0$ and the stock price remains constant.

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

any debt is issued. $($Do not round intermediate calculations and enter your

answers as a percent rounded to $2$ decimal places, e$.$g$.,32\mathrm{.}16.)$

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

recession. $($A negative answer should be indicated by a minus sign. Do not round

intermediate calculations and enter your answers as a percent rounded to $2$

decimal places, e$.$g$.,32\mathrm{.}16.)$

b$-1.$ Assume the firm goes through with the proposed recapitalization. Calculate the

return on equity $($ROE$)$ under each of the three economic scenarios. $($Do not round

intermediate calculations and enter your answers as a percent rounded to $2$

decimal places, e$.$g$.,32\mathrm{.}16.)$

b$-2.$ Assume the firm goes through with the proposed recapitalization. Calculate the

percentage changes in ROE when the economy expands or enters a recession. $($A

negative answer should be indicated by a minus sign. Do not round intermediate

calculations and enter your answers as a percent rounded to $2$ decimal places,

e$.$g$.,32\mathrm{.}16.)$

Assume the firm has a tax rate of $22$ 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 and enter your

answers as a percent rounded to $2$ decimal places, e$.$g$.,32\mathrm{.}16.)$

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

recession. $($A negative answer should be indicated by a minus sign. Do not round

intermediate calculations and enter your answers as a percent rounded to $2$

decimal places, e$.$g$.,32\mathrm{.}16.)$

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 and enter your answers as a percent rounded to $2$

decimal places, e$.$g$.,32\mathrm{.}16.)$

c$-4.$ Given the recapitalization, calculate the percentage changes in ROE when the

economy expands or enters a recession. $($A negative answer should be indicated

by a minus sign. Do not round intermediate calculations and enter your answers

as a percent rounded to $2$ decimal places, e$.$g$.,32\mathrm{.}16.)$