Problem one with answers is the attached image. The question:

ROE and Leverage - Suppose the company in Problem 1 has a market-tobook ratio of 1.0 and the stock price remains constant. 'a. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in ROE for economic expansion and recession, assuming no taxes. 'b. Repeat part (a) assuming the firm goes through with the proposed recapitalization. c. Repeat parts (a) and (b) of this problem assuming the firm has a tax rate of 21 percent.

7 EBIT Question 1. (20 points) EBIT and Leverage [LO1] Ghost, Inc., has no debt outstanding and a total marketvalue Strong of $185,000. Earnings before interest and taxes, EBIT, are projected to be $29,000 if economic conditions are 8 Recession normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a 9 recession, then EBIT will be 40 percent lower. The company is considering a $65,000 debt issue with an Debt issued 10 interest rate of 7 percent. The proceeds will be used to repurchase shares of stock. There are currently 7,400 Interest shares outstanding. Ignore taxes for this problem. $ 29,000.00 30% 40% $ 65,000.00 7% Shares outstanding 7400 11 12 a. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in EPS when the economy expands or enters a recession. 13 14 Recession EPS $ 2.35 15 Normal EPS $ 3.92 16 Expansion EPS $ 5.09 17 Recessoin percentage change in EPS -40% 18 Expansion in percentage change in EPS 30% 19 20 4800 21 22 b. Repeat part (a) assuming that the company goes through with recapitalization. What do you observe? 23 24 New Number of Shares If the company goes through 25 Recession EPS $ 2.68 recapitalization I observe that the EPS 26 Normal EPS $ 5.09 will be higher with debt in the capital 27 Expansion EPS $ 6.91 o structure. O 28 Recessoin percentage change in EPS -47% 29 Expansion in percentage change in EPS 36% 30