Question

Broward Manufacturing recently reported the following information:

Net income	$738,000
ROA	10%
Interest expense	$243,540
Accounts payable and accruals	$1,050,000

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). Do not round intermediate calculations. Round your answers to two decimal places.

BEP:   %

ROE:   %

ROIC:   %

Answer 1

Net Income = $738,000

ROA (Return On Assets) = 10%

Interest Expense = $243,540

Accounts Payable and Accruals = $1,050,000

Tax Rate = 25%

Debt = 40% of Total Invested Capital

Common Equity = 60% of Total Invested Capital

1.

Basic Earning Power (BEP) % = ( EBIT /Total Assets) * 100

Now,

Net Income = Earnings before tax - Tax expense
$738,000 = Earnings before tax - 25% of Earning before tax
$738,000 = 75% of Earnings before tax
Earnings before tax = $738,000 / 75%
Earnings before tax = $984,000
EBIT - Interest = Earnings before tax
EBIT = Earnings before tax + Interest
EBIT = $984,000 + $243,540
EBIT = $1,227,540

ROA = Net Income / Total Assets

10% = $738,000 / Total Assets

Total Assets = $738,000 / 10%

= $7,380,000

So, BEP % = ($1,227,540 / $7,380,000) *100

= 0.166333 *100

=16.6333

= 16.63% (rounded off)

2.

ROE (Return On Equity) % = (Net Income / Common Equity) * 100

Common Equity = 60% of Total Invested Capital

Total Assets = Liabilities (Accounts Payable and Accruals in this case) + Total Invested Capital

​​​​​$7,380,000 = $1,050,000 + Total Invested Capital

Total Invested Capital = $7,380,000 - $1,050,000

Total Invested Capital = $6,330,000

So, Common Equity = 60% of $6,330,000

Common Equity = $3,798,000

Now,

ROE % = ($738,000 / $3,798,000) * 100

= 0.194312 *100

=19.4312%

=19.43% (rounded off)

3.

ROIC (Return on Invested Capital) % = {EBIT (1 - T)} / Total Invested Capital

=[ { $1,227,540 (1 - 25%) } / $6,330,000 ] *100

= [ { $1,227,540 (1 - 0.25) } / $6,330,000 ] *100

=[ ( $1,227,540 * 0.75) / $6,330,000 ] *100

=($920,655 / $6,330,000) *100

= 0.145443 *100

= 14.5443%

=14.54% (rounded off)