Question

Duffert Industries has total assets of $1,050,000 and total current liabilities (consisting only of accounts payable and accruals) of $150,000. Duffert finances using only long-term debt and common equity. The interest rate on its debt is 9% and its tax rate is 40%. The firm's basic earning power ratio is 15% and its debt-to capital rate is 40%. What are Duffert's ROE and ROIC

Answer 1

Answer:

13.90%; 10.50%

Explanation:

Given that,

Total assets = $1,050,000

Total current liabilities = $150,000

Interest rate on debt = 9%

Tax rate = 40%

Basic earning power ratio = 15%

Debt-to-capital rate = 40%

$Basic\ earning\ power\ ratio=\frac{EBIT}{Total\ assets}$

$0.15=\frac{EBIT}{1,050,000}$

EBIT = 0.15 × $1,050,000

        = $157,500

Total invested capital:

= Total assets - Accounts payable and accruals

= $1,050,000 - $150,000

= $900,000

Equity = 60% of the total invested capital

           = 0.6 × $900,000

           = $540,000

Debt = Total invested capital - Equity

        = $900,000 - $540,000

        = $360,000

Earning before tax:

= EBIT - Interest expense

= $157,500 - ($360,000 × 9%)

= $157,500 - $32,400

= $125,100

Net income = Earning before tax - Tax expense

                    = $125,100 - ($125,100 × 40%)

                    = $125,100 - $50,040

                    = $75,060

ROE:

= Net income ÷ Equity

= $75,060 ÷ $540,000

= 0.1390 or 13.90%

ROIC:

$=\frac{[EBIT(1-Tax\ rate)]}{Total\ operating\ capital}$

$=\frac{[157,500(1-0.4)]}{900,000}$

= 0.1050 or 10.50%