Fujita, Incorporated, has no debt outstanding and a total market value of $450,000. Earnings before interest and taxes, EBIT, are projected to be $57,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 16 percent higher. If there is a recession, then EBIT will be 24 percent lower. The company is considering a $215,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 9,000 shares outstanding. Ignore taxes for questions (a) and (b). Assume the company has a market- to-book ratio of 1.0 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., 32.16.) 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 decimal places, e.g., 32.16.) 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., 32.16.) 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., 32.16.) a-1. Recession ROE a-1. Normal ROE a-1. Expansion ROE a-2. Recession percentage change in ROE 3.61 % 4.75 % 5.51 % -24.00 % 16.000
Fujita, Incorporated, has no debt outstanding and a total market value of $450,000. Earnings before interest and taxes, EBIT, are projected to be $57,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 16 percent higher. If there is a recession, then EBIT will be 24 percent lower. The company is considering a $215,000 debt issue with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 9,000 shares outstanding. Ignore taxes for questions (a) and (b). Assume the company has a market- to-book ratio of 1.0 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., 32.16.) 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 decimal places, e.g., 32.16.) 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., 32.16.) 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., 32.16.) a-1. Recession ROE a-1. Normal ROE a-1. Expansion ROE a-2. Recession percentage change in ROE 3.61 % 4.75 % 5.51 % -24.00 % 16.000
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Concept explainers
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
Transcribed Image Text:Fujita, Incorporated, has no debt outstanding and a total market value of $450,000.
Earnings before interest and taxes, EBIT, are projected to be $57,000 if economic
conditions are normal. If there is strong expansion in the economy, then EBIT will be 16
percent higher. If there is a recession, then EBIT will be 24 percent lower. The
company is considering a $215,000 debt issue with an interest rate of 8 percent. The
proceeds will be used to repurchase shares of stock. There are currently 9,000 shares
outstanding. Ignore taxes for questions (a) and (b). Assume the company has a market-
to-book ratio of 1.0 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., 32.16.)
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., 32.16.)
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., 32.16.)
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., 32.16.)
a-1. Recession ROE
a-1. Normal ROE
a-1. Expansion ROE
a-2. Recession percentage change in ROE
a-2. Expansion percentage change in ROE
b-1. Recession ROE
b-1. Normal ROE
b-1. Expansion ROE
b-2. Recession percentage change in ROE
b-2. Expansion percentage change in ROE
3.61 %
4.75 %
5.51 %
-24.00 %
16.00 %
4.17 %
6.35 %
7.81 %
-34.37 %
22.91%
Transcribed Image Text:Assume the firm has a tax rate of 25 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., 32.16.)
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., 32.16.)
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., 32.16.)
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., 32.16.)
c-1. Recession ROE
c-1. Normal ROE
c-1. Expansion ROE
c-2. Recession percentage change in ROE
c-2. Expansion percentage change in ROE
c-3. Recession ROE
c-3. Normal ROE
c-3. Expansion ROE
c-4. Recession percentage change in ROE
c-4. Expansion percentage change in ROE
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