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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

ROE AND ROIC Hilyard Industries’ net income is $25,000, its interest expense is $5,000, and its tax rate is 40%. Its notes payable equals $25,000, long-term debt equals $75,000, and common equity equals $250,000. The firm finances with only debt and common equity, so it has no preferred stock. What arc the firm’s ROE and ROIC?

Summary Introduction

To determine: Return on equity (ROE) and return on invested capital (ROIC).

Return on Equity: Return on equity represents the amount of return earned by equity share holders; it can be calculated by dividing earnings available for equity share holders to total equity capital.

Return on Invested Capital (ROIC): It represents the amount of return earned by all the investors; it can be calculated by dividing earnings available for investors to total invested capital.

Explanation

Solution:

Given,

Net income is $25,000.

Long term debt is $75,000.

Common equity is $250,000.

Calculated values,

Earnings before interest and tax are $46666.67.

Formula to calculate return on equity,

Return on equity=NetincomeCommonequity

Substitute $25,000 for net income and $250,000 for common equity in the above formula,

Return on equity=$25,000$250,000=0.1or10%

Here, return on equity is 10%.

Formula to calculate return on invested capital,

Return on invested capital=Earning beforeinterestandtax×(1Tax)Debt+Commonequity

Substitute $46666.67 for earnings before interest and tax, 0.4 for tax, $75,000 for debt and $250,000 for common equity in the above formula,

Return on invested capital=$46666.67×(10.4)$75,000+$250,000=$46666

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