If a firm has an ROE of 15 percent, a financial cost effect of 0.9 and a pre-tax

Question

If a firm has an ROE of 15 percent, a financial cost effect of 0.9 and a pre-tax ROIC of 10 percent, what is its debt-to-equity ratio (total debt divided by owners' equity)? Assume that the firm does not pay any tax If a firm has an ROE of 15 percent, a financial cost effect of 0.9 and a pre-tax ROIC of 10 percent, what is its debt-to-equity ratio (total debt divided by owners' equity)? Assume that the firm does not pay any tax If a firm has an ROE of 15 percent, a financial cost effect of 0.9 and a pre-tax ROIC of 10 percent, what is its debt-to-equity ratio (total debt divided by owners' equity)? Assume that the firm does not pay any tax

Explanation / Answer

Answer

Financial cost effect is of 0.9

So If EBIT = 1

Then Interest cost will be = 0.9

EBT = 0.1

ROE = EBT / Equity

0.15 = 0.1 / Equity

Equity = 0.1 / 0.15

Equity = 0.67

ROIC = EBIT / Equity + Debt

0.1 = 1 / 0.67 + Debt

0.67 + Debt = 1/0.1

0.67 + Debt = 10

Debt = 10 – 0.67

Debt = 9.33

Debt-to-equity ratio = Debt / Equity

                                      = 9.33 / 0.67

Debt-to-equity ratio = 13.99 times

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