Question

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: $4.9 million with a 0.2 probability, $2.5 million with a 0.5 probability, and $0.7 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.

1) Debt/Capital ratio is 0.

2)Debt/Capital ratio is 10%, interest rate is 9%.

3) Debt/Capital ratio is 50%, interest rate is 11%.

4) Debt/Capital ratio is 60%, interest rate is 14%.

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -