Question

ABC Inc. has $2 million in assets, $100,000 of EBIT, and a 25% tax rate. ABC has a debt/assets ratio of 40% and pays 4% interest on its debt. What is ABC’s return on equity? (10 points)

Answer 1

Answer :- ABC's return on equity = 4.25%

Calculation :-

Return on equity = Net Income / Equity

As given debt-asset ratio is 40% and asset value is 2 million

Debt-Asset Ratio = Debt / Asset

40% = Debt / 2 million

Debt = 0.80 million or 800,000

Interest on debt = 800,000 * 4%

= 32,000

Total Asset = Equity + Debt

2 million = Equity + 0.80 million

Equity = 1.20 million

EBT = EBIT - Interest

= 100,000 - 32,000

= 68,000

Net Income = EBT - Tax

= 68,000 - ( 68,000 * 0.25)

= 68,000 - 17000

= 51,000

ROE = Net Income / Equity

= 51,000 / 1,200,000

= 0.0425 or 4.25%