Question

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).

Answer 1

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