The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $11 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.5 million with a 0.2 probability, $2.2 million with a 0.5
probability, and $0.6 million with a 0.3 probability. Calculate
Neal's expected ROE, standard deviation, and coefficient of
variation for each of the following debt-to-capital ratios. Do not
round intermediate calculations. Round your answers to two decimal
places at the end of the calculations.
Debt/Capital ratio is 0. RÔE = % σ = % CV =
Debt/Capital ratio is 10%, interest rate is 9%. RÔE = % σ = % CV
=
Debt/Capital ratio is 50%, interest rate is 11%. RÔE = % σ = %
CV = Debt/Capital ratio is 60%,
interest rate is 14%. RÔE = % σ = % CV =
Solutions
Expert Solution
(a) Debt/Capital ratio is 0
Probability is 0.2, 0.5,0.3 for the EBIT 5,500,000, 2,200,000,
600,000 respectively
Total capital = equity = 11,000,000
Total capital
11
Debt
0
Interest
0
Equity
11
Tax
40%
State
Probability
EBIT
(EBIT-i)*(1-t)
ROE
Prob*ROE
Prob*[ROE-E(ROE)]^2
1
0.2
5.5
3.3
30.00%
6.00%
0.5792%
2
0.5
2.2
1.32
12.00%
6.00%
0.0048%
3
0.3
0.6
0.36
3.27%
0.98%
0.2828%
E(ROE)
(Sum(ROE))
12.98%
Variance(Sum(Prob*[ROE-E(ROE)]^2))
0.8669%
Standard deviation sd
(Sqrt(variance))
9.311%
CV
(sd/E(ROE)
0.71720
Sigma is the standard deviation
E(ROE) is the required ROE
(b)
Debt/Capital ratio is 10%, the interest rate is 9%
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $19 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$4.2 million with a 0.2 probability, $2 million with a 0.5
probability, and $0.5 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $16 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.2 million with a 0.2 probability, $1.5 million with a 0.5
probability, and $0.4 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $14 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$4.7 million with a 0.2 probability, $1.7 million with a 0.5
probability, and $0.6 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $14 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$4.4 million with a 0.2 probability, $2.8 million with a 0.5
probability, and $0.3 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $17 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 25%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.5 million with a 0.2 probability, $2.4 million with a 0.5
probability, and $500,000 with a 0.3...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $16 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 25%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.2 million with a 0.2 probability, $2 million with a 0.5
probability, and $400,000 with a 0.3...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $15 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.4 million with a 0.2 probability, $3.1 million with a 0.5
probability, and $0.3 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $13 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.6 million with a 0.2 probability, $2.9 million with a 0.5
probability, and $0.4 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $18 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5 million with a 0.2 probability, $2 million with a 0.5
probability, and $0.9 million with a...
The Neal Company wants to estimate next year's return on equity
(ROE) under different financial leverage ratios. Neal's total
capital is $18 million, it currently uses only common equity, it
has no future plans to use preferred stock in its capital
structure, and its federal-plus-state tax rate is 40%. The CFO has
estimated next year's EBIT for three possible states of the world:
$5.1 million with a 0.2 probability, $3.3 million with a 0.5
probability, and $0.5 million with a...
jeff jeffy answered 1 year ago