Question

Baker Industries’ net income is $25,000, its interest expense is $4,000, and its tax rate is 45%. Its notes payable equals $27,000, long-term debt equals $70,000, and common equity equals $260,000. 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

ROE is computed as shown below:

= Net income / common equity

= $ 25,000 / $ 260,000

= 9.62% Approximately

ROIC is computed as shown below:

= [ EBIT x (1 - tax rate) ] / (notes payable + long term debt + common equity)

EBIT is computed as follows:

= [ Net income / (1 - tax rate) ] + Interest

= [ $ 25,000 / (1 - 0.45) ] + $ 4,000

= $ 49,454.54545

So, the ROIC will be computed as follows:
= [ $ 49,454.54545 x (1 - 0.45) ] / ($ 27,000 + $ 70,000 + $ 260,000)

= $ 27,200 / $ 357,000

= 7.62% Approximately

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