Question

Broward Manufacturing recently reported the following information:

Net income	$725,000
ROA	9%
Interest expense	$282,750
Accounts payable and accruals	$950,000

Broward's tax rate is 40%. Broward finances with only debt and common equity, so it has no preferred stock. 40% of its total invested capital is debt, while 60% of its total invested capital is common equity. Calculate its basic earning power (BEP), its return on equity (ROE), and its return on invested capital (ROIC). Round your answers to two decimal places.

Answer 1

ROA (Return on Assets) = Net Income / Total assets

or, 0.09 = $725,000 / Total assets

or, Total assets = $8,055,555.55555

Total assets = Total liabilities

or, $8,055,555.55555 = Accounts payable and accruals + Total invested capital

or, Total invested capital = $8,055,555.55555 - $950,000 = $7,105,555.55555

Total debt = 40% x $7,105,555.55555 = $2,842,222.22222

Total equity = 60% x $7,105,555.55555 = $4,263,333.33333

Basic Earning Power

EBT = Net Income / (1 - tax rate) = $725,000 / (1 - 0.40) = $1,208,333.33333

EBIT = EBT + Interest expense = $1,208,333.33333 + $282,750 = $1,491,083.33333

Basic Earning Power = EBIT / Total assets = $1,491,083.33333 / $8,055,555.55555 = 0.1851 or 18.51%

Return on Equity

ROE = Net income / Total equity = $725,000 / $4,263,333.33333 = 0.1701 or 17.01%

Return on invested capital

Net Operating profit after taxes (NOPAT) = EBIT x (1 - Tax rate) = $1,491,083.33333 - (1 - 40%) = $894,650

ROIC = NOPAT / Total invested capital = $894,650 / $7,105,555.55555 = 0.1259 or 12.59%