Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
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Finance/Business
- Thread starter Khole
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Khole said:Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
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This is the answer that I got is this right.
Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
Solution:
Firm A: D/TA=50%
EBIT = $400,000
Interest ($1,000000 x 0.12) = 120,000
EBT = $280,000
Tax (40%) 112,000
Net Income $168,000
Return on equity =$168,000/$1,000000=16.8%
Firm B: D/TA=30%
EBIT =$400,000
Interest ($600,000 x 0.10) = 60,000
EBT $340,000
Tax (40%) 136,000
Net income $204,000
Return on equity = $204,000/$1,400,00=14.6%
Answer: 2.2%
Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
Solution:
Firm A: D/TA=50%
EBIT = $400,000
Interest ($1,000000 x 0.12) = 120,000
EBT = $280,000
Tax (40%) 112,000
Net Income $168,000
Return on equity =$168,000/$1,000000=16.8%
Firm B: D/TA=30%
EBIT =$400,000
Interest ($600,000 x 0.10) = 60,000
EBT $340,000
Tax (40%) 136,000
Net income $204,000
Return on equity = $204,000/$1,400,00=14.6%
Answer: 2.2%
This is the answer that I got is this right.
Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
Solution:
Firm A: D/TA=50%
EBIT = $400,000
Interest ($1,000000 x 0.12) = 120,000
EBT = $280,000
Tax (40%) 112,000
Net Income $168,000
Return on equity =$168,000/$1,000000=16.8%
Firm B: D/TA=30%
EBIT =$400,000
Interest ($600,000 x 0.10) = 60,000
EBT $340,000
Tax (40%) 136,000
Net income $204,000
Return on equity = $204,000/$1,400,00=14.6%
Answer: 2.2%
Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt, while Firm B has a 30% debt ratio and pays only 10% interest on its debt. What is the difference between the two firms' ROEs?
Solution:
Firm A: D/TA=50%
EBIT = $400,000
Interest ($1,000000 x 0.12) = 120,000
EBT = $280,000
Tax (40%) 112,000
Net Income $168,000
Return on equity =$168,000/$1,000000=16.8%
Firm B: D/TA=30%
EBIT =$400,000
Interest ($600,000 x 0.10) = 60,000
EBT $340,000
Tax (40%) 136,000
Net income $204,000
Return on equity = $204,000/$1,400,00=14.6%
Answer: 2.2%