Financial leverage effects The Neal Company wants to estimate next year\'s retur
ID: 2655516 • Letter: F
Question
Financial leverage effects
The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $13 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5 million with a 0.2 probability, $2.6 million with a 0.5 probability, and $400,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.
Debt/Capital ratio is 10%, interest rate is 9%.
Debt/Capital ratio is 50%, interest rate is 11%.
Debt/Capital ratio is 60%, interest rate is 14%.
RÔE = % = % CV =Explanation / Answer
Answer:Debt/Capital ratio is 10%, interest rate is 9%.
Total capital=13000,000
Debt =1300000
Equity=11700000
ROE=(Expected EAT/Equity)*100
=(1381800/11700000)*100
=11.8103%
Debt/Capital ratio is 50%, interest rate is 11%.
Total capital=13000,000
Debt =6500,000
Equity=6500,000
ROE=(Expected EAT/Equity)*100
=(1023000/6500,000)*100
=15.7385%
Debt/Capital ratio is 60%, interest rate is 14%.
Total capital=13000,000
Debt =7800,000
Equity=5200,000
ROE=(Expected EAT/Equity)*100
=(796800/5200,000)*100
=15.3231%
Particulars Ist state IInd state IIIrd state Total EBIT 5000000 2600000 400000 Less: interest 117000 117000 117000 EBT 4883000 2483000 283000 Less: tax 1953200 993200 113200 EAT 2929800 1489800 169800 Probability 0.2 0.5 0.3 Expected EAT 585960 744900 50940 1381800Related Questions
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