Question

Baker Industries’ net income is $23,000, its interest expense is $6,000, and its tax rate is 40%. Its notes payable equals $25,000, long-term debt equals $70,000, and common equity equals $240,000. The firm finances with only debt and common equity, so it has no preferred stock. What are the firm’s ROE and ROIC? Do not round intermediate calculations. Round your answers to two decimal places.

Answer 1

Solution:-

1) Calculate the Return of Equity (ROE) of Baker industries:

Return of Equity = Net income/Common equity

= $23,000/$240,000

= 9.5833%

The ROE of Baker industries is 9.58%.

2) Calculation of Return on Investor's capital (ROIC) of Baker industries:

ROIC = NOPAT/Investor's capital

= $26,600/$335,000

= 7.94%.

WOKING NOTE:

Calculation of earnings before tax.

EBT = Net income/(1-tax rate)
= $23,000/(1-40%)

= $23,000/60%

= $38333.33

Calculation of earnings before interest and tax.

EBIT = EBT + Interest expense

= $38,333.33+$6,000

= $44,333.33

Calculation of Net operating profit after tax(NOPAT).

NOPAT = EBIT * (1-TAX RATE)

= $44,333.33 * (1-40%)

= $44,333.33 * 60%

= $26,600

Calculation of Investor's capital.

INVESTOR'S CAPITAL = DEBT + EQUITY

= ($70,000+$25,000) + $240,000

= $95,000+$240,000

= $335,000.

The ROE of Baker industries is 9.58%.

The ROIC of Baker industries is 7.94%.