Question

There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million if an economic expansion occurs, or as low as $2 million if a recession occurs. All values are market values. What is ROE for the proposed capital structure if the expected state occurs?

Answer 1

The Return on Equity (ROE) for the proposed capital structure can be calculated using the expected EBIT and the equity. However, since we don't have the exact equity value, we can only determine the range for the ROE using the high and low EBIT values.

Step-by-step explanation:

The Return on Equity (ROE) for the proposed capital structure can be calculated by dividing the expected EBIT (Earnings Before Interest and Taxes) by the equity. In this case, the EBIT is expected to be $2.5 million. To find the equity, we need to consider the potential scenarios for EBIT - high and low. If the economic expansion occurs, EBIT could be as high as $3.5 million, and if a recession occurs, EBIT could be as low as $2 million. We'll use the expected EBIT of $2.5 million for the calculation.

ROE = EBIT / Equity
ROE = $2.5 million / Equity

Since we don't have the exact equity value, we can't calculate the exact ROE. However, we can determine the range for the ROE using the high and low EBIT values:

Low ROE = $2 million / Equity
High ROE = $3.5 million / Equity

Therefore, the ROE for the proposed capital structure would be between ($2 million / Equity) and ($3.5 million / Equity).