Suppose operating costs are now $125,000 for either the 100% equity or 50/50 sce

Question

Suppose operating costs are now $125,000 for either the 100% equity or 50/50 scenario. What is the return on equity for each scenario?

All Equity 50% Debt Balance Sheet Current assets $100,00 $100,000 fixed assets 100,00 100,000 total assets $200,000 $200,000 bank loan (10% cost) $0 $100,000 common stock 200,000 100,000 total liabilities and equity $200,000 $200,000 Income statements revenues $150,000 $150,000 operating costs 100,000 100,000 operating income $50,000 $50,000 interest expense 0 10,000 taxable income $50,000 40,000 taxes 40% 20,000 16,000 net income 30,000 24,000 ROE 15% 24% tax dollar return to investors 30,000 34,000

Explanation / Answer

ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder's Equity

So in first case = 30,000 / 200,000

= 15%

and in the second case = 24,000/ 100,000

= 24%

All equity 50-50 revenues 150000 150000 operating costs 125000 125000 operating income 25000 25000 interest expense 0 10000 taxable income 25000 15000 taxes 40% 10000 6000 net income 15000 9000 ROE 7.5% 9.0%

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