Financial leverage effects The Neal Company wants to estimate next year\'s retur
ID: 2655687 • 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 $12 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: $5.8 million with a 0.2 probability, $1.6 million with a 0.5 probability, and $500,000 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 0.
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
The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $12 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: $5.8 million with a 0.2 probability, $1.6 million with a 0.5 probability, and $500,000 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 0.
ROE = 10.55%
SD = Variance^(1/2)
SD = 0.00907725^(1/2)
SD = 9.53%
CV = SD/Expected ROE
CV = 9.53%/10.55%
CV = 0.90
Debt/Capital ratio is 10%, interest rate is 9%.
ROE = 11.12%
SD = Variance^(1/2)
SD =0.011239225^(1/2)
SD = 10.60%
CV = SD/ROE
CV = 10.60%/11.12%
CV = 0.95
Debt/Capital ratio is 50%, interest rate is 11%.
ROE = 14.50%
SD = Variance^(1/2)
SD = 0.03786925^(1/2)
SD = 19.46%
CV = SD/ROE
CV = 19.46%/14.50%
CV = 1.34
Debt/Capital ratio is 60%, interest rate is 14%.
ROE = 13.78%
SD = Variance^(1/2)
SD = 0.057772875^(1/2)
SD = 24.04%
CV = SD/ ROE
CV = 24.04%/13.78%
CV = 1.74
Total Capital Debt Total Equity EBIT Interest Expenses EBT Tax Expenses Net Income [a] [b] [c = a-b] [d] [e] [f = d-e] [g = f*40%] [h = f-g] 12,000,000 0 12,000,000 5800000 0 5800000 2320000 3480000 12,000,000 0 12,000,000 1600000 0 1600000 640000 960000 12,000,000 0 12,000,000 500000 0 500000 200000 300000 ROE Probability [ROE*Prob] [ Expected RoE - ROE]^2 Variance [i= h/c] [j ] [K = i*j] [L = (i-10.55%)^2 [ M = L*J] 29.00% 0.2 5.80% 0.0340403 0.00680805 8.00% 0.5 4.00% 0.0006503 0.000325125 2.50% 0.3 0.75% 0.0064803 0.001944075 Expected ROE = 10.55% Variance = 0.00907725Related Questions
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