14-5
Solution:
Given Data
Assets
EBIT
Tax
Debt Ratio
Interest
HL
$ 20,000,000
$
4,000,000
40%
50%
12%
LL
$
$
20,000,000
4,000,000
40%
30%
10%
a. Return on equity(ROE)
EBIT
Debt Interest*
EBT(EBIT - Interest)
Tax(40% X EBT)
Net Incom(NI)
HL
$
$
$
$
$
ROE = (NI/Equity)
4,000,000
1,200,000
2,800,000
1,120,000
1,680,000
16.8%
LL
$
$
$
$
$
4,000,000
600,000
3,400,000
1,360,000
2,040,000
*Interest
Debt ratio = Debts/Assets
Debts = Debt ratio X Assets,
hence for HL, Interest on debts =
50% X $ 20m X 12%
and for LL Interest on debts = 30% X
20m X 10%
ROE = NI/Equity
Equity = Assets - Debt
14.6%
b. New Return on equity(ROE) for LL on 60% debt ratio and 15% interest on debts
Given Data
EBIT
Debt Interest*
EBT(EBIT - Interest)
Tax(40% X EBT)
Net Incom(NI)
ROE = (NI/Equity)
LL
$
$
$
$
4,000,000
1,800,000
2,200,000
880,000
$
1,320,000
16.5%