Question

Baker Industries’ net income is $24,000, its interest expense is $4,000, and its tax rate is 35%. Its notes payable equals $25,000, long-term debt equals $80,000, and common equity equals $250,000. The firm finances with only debt and common equity, so it has no preferred stock. What are the firm’s ROE and ROIC? Round your answers to two decimal places. Do not round intermediate calculations.

ROE %
ROIC %

Answer 1

Let’s first calculate the Return of Equity (ROE)

ROE = Net income / Total Equity

Where,

Net income = $24,000

Total equity = $250,000

Therefore,

ROE = $24,000 /$250,000

=0.0960 or 9.60%

Return on invested capital (ROIC) mean average return generated by total invested capital (both debt and equity)

ROIC = Income before interest and taxes * (1- tax rate)/ (Total invested capital)

Where,

Tax rate = 35%

Income before interest and taxes = {Net income / (1- tax rate)} + interest expense

= {$24,000 / (1- 35%)} + $4,000

= {$24,000 / (0.65)} + $4,000

=$36,923.08 +$4,000

=$40,923.08

And total invested capital = notes payable + long-term debt + common equity

= $25,000 + $80,000 + $250,000

= $355,000

Now putting these values into ROIC formula

ROIC = $40,923.08 *(1-35%) / $355,000

= $40,923.08 *(0.65) / $355,000

= $26,600 / $355,000

= 0.0749 or 7.49%

Therefore firm’s

ROE = 9.60%

ROIC = 7.49%