Question

Baker Industries’ net income is $21,000, its interest expense is $6,000, and its tax rate is 25%. Its notes payable equals $23,000, long-term debt equals $80,000, and common equity equals $240,000. The firm finances with only debt and common equity, so it has no preferred stock.

What are the firm’s ROE and ROIC? Do not round intermediate calculations. Round your answers to two decimal places.

Answer 1

Given that;
Net income=$21,000
Interest expenses=$6,000
Tax rate=25%
Notes payable=$23,000
Long term debt=$80,000
Common equity=$240,000

ROE=(Net income)/(Common equity)=21000/240000
=0.0875 or 8.75%

Now, (Earnings before tax)*(1-tax)=Net income
=>(Earnings before tax)=Net income/(1-tax)
=21000/(1-25%)=28000

So, earnings before tax or EBT =$28000

Earnings before interest & tax or EBIT=Earnings before tax + Interest expense
=28000 + 6000=34000

Given that the firm finances with only debt and common equity. Notes payable are also current liabilities or short term debt. So, we can calculate the invested capital as:
Capital invested=Notes payable + Long term debt + Common equity
=23000+80000+240000=343000

ROIC=(EBIT)*(1-Tax rate)/(Capital invested)
=(34000)*(1-25%)/(343000)
=(25500)/(343000)
=0.074344023 or 7.43% (Rounded to 2 decimal places)

Answer: Hence, the value of ROE is 8.75% and the value of ROIC is 7.43%

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