Question

XYZ Corp has total assets of $1,000,000 and a debt ratio of 30%. Currently it has sales of $2,500,000, total fixed costs of $1,000,000, and EBIT of $50,000. If XYZ pays 6% interest on debt, what is XYZ's ROE? Group of answer choices 1.7% 2.5% 6.0% 8.3% 9.8%

Tax Rate Not provided in question, but most likely the new corporate flat-tax rate of 21%.

Answer 1

Ans 1. The debt ratio can be used to calculate the liability of the balance sheet. The debt ratio is 30% which as per the formula Total Liability/Total Asset. As per the information provided debt ratio is 30% and Total asset is $1,000,000 the Total Liability is 30% of 1,000,000 = $3,00,000

As liability is $3,00,000 the share holder equity is $7,00,000

Interest on debt is 6% considering the liability has debt. Hence 6% of $3,00,000 is $18000

Using the formula

ROE = (Operating margin * turnover ratio - Borrow cost) * Equity * (1-tax)

ROE = ( EBIT/Sales * Sales/Total Asset - Interest Expense/ Total Asset) * Total Asset/Equity * (1-tax)

ROE= (50,000/2,50,000 * 2,50,000/1,000,000 - 18,000/1,000,000) * 1,000,000/7,00,000 * (1-21%)

ROE = (.032)*1.12 =0.03611 = 3.6%

If we calculate from another formula of Net Income/Total Share Holder Equity

The EBT is $50,000 - $18,000 (Interest) = $32,000

PAT is $32,000 * .79 = $25280

PAT/SHE = 25280/700000 = 3.6%

The asnwers are based on the tax rate which is provided