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Broward Manufacturing recently reported the following information: Net income $228,000 ROA 8% Interest expense $91,200 Accounts...

Broward Manufacturing recently reported the following information: Net income $228,000 ROA 8% Interest expense $91,200 Accounts payable and accruals $950,000 Broward's tax rate is 25%. Broward finances with only debt and common equity, so it has no preferred stock. 40% of its total invested capital is debt, and 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).

Solutions

Expert Solution

Hi,

Return on asset ROA = Net Income/ Total Assets

Or, Total Assets = Net Income/ ROA

                             = $228,000/ 0.08 = $2,850,000

Total Assets = Equity + Liabilities,

Total Assets A = Equity + Current Liabilities (CL) + Long Term Liabilities (LTL)

Here,

Here Current Liabilities = Accounts payable and accruals = $950,000

The Long Term Liabilities represent the Debt.

Hence Equity + Debt = A - CL = $2850000 - $950000 = $1,900,000

and

Equity + Debt = Total Invested Capital (IC)

So, IC = $1,900,000

2. Calculation of Equity

As per the question

Debt = 40% of IC = 40%*1900000 = $760,000

Equity = 60% of IC = 60%*1900000 = $1,140,000

We know that Net Income = (EBIT - interest)*(1-tax rate)

EBIT(1-t) = Net income + Interest*(1-t)

tax rate t = 25%

So EBIT(1- t) = 228000+ 91200*0.75

EBIT(1-t) = $296,400

Also EBIT= $296400/ 0.75 = $395,200

now

Basic Earning Power = EBIT/ Total Assets

basic Earning Power = 395200/2850000 = 13.87%

ROE = Net Income/ Equity

ROE = 228000/ 1140000 = 20%

ROIC = EBIT(1-T)/Total Invested Capital.

ROIC = 296400/1900000 = 15.6%

Thanks


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