Question

GraLuc, Inc. has $2,000,000 in total assets. The company is expecting an EBIT of $200,000 next year. The company's structure consists of 1, 200,000 of long-term debt with a 10% coupon and 80,000 share of common stock with a $10 par value. The tax rate is 25%. What is the company's return on Equity? 3.8% 7.5% 25.0% 75.0%

Answer 1

Given,

EBIT = $200000

Long term debt = $1200000

Coupon rate = 10%

Common stock = 80000 shares

Price per share = $10

Tax rate = 25% or 0.25

Solution :-

Interest expense = Long term debt x coupon rate

= $1200000 x 10% = $120000

Net income = (EBIT - interest expense) x (1 - tax rate)

= ($200000 - $120000) x (1 - 0.25)

= $80000 x 0.75 = $60000

Shareholders' equity = common stock x price per share

= 80000 shares x $10 = $800000

Now,

Company's return on equity = Net income shareholders' equity

= $60000 $800000 = 0.075 or 7.5%

So, the company's return on equity is 7.5%