Question

exotica limited has $ 5 lacs in assets that are financed with 100% equity. The fixed...

exotica limited has $ 5 lacs in assets that are financed with 100% equity.

The fixed cost = $ 1.2 lacs.

The EBIT of the company for the year i = $ 80000.

tax rate is = 40%.

In case its EBIT increases by 10%and reduces by 10% Define, calculate & interpret the
a. Net income
b. Return on equity

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Answer #1

a. Net income : Net income is net earnings after deducting all expenses, depreciation, tax and interest from income.

b. Return on equity: Return on Equity is an important indicator to shareholders of the firm. It measure the profitability of equity fund invested in the firm.

ROE = Net income /Average equity

Calculation:

Current 10% increase 10% decrease
EBIT 80,000 88,000 72,000
Tax rate 40% 32000 35200 28800
Net income 48000 52800 43200
Return on equity 48,000/500,000=9.6% 52800/500,000=10.56% 43200/500000=8.64%

Interpret:

1. When EBIT incease and tax rate remain same Net income increase or decrease in proportion of EBIT.

2. IF Company is 100% finance by equity. Then ROE increase or decrease in proportion to Net income.

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