Answer:
Return on equity would increase from 8.33% to 9.50%
Explanation:
The tax rate of 40% is missing from the question.
Return on equity prior to share repurchase=$500,000/$6,000,000
Return on equity prior to share repurchase=8.33%
With the issue of debt finance of $2,000,000, the after-tax interest expense is computed thus:
after-tax interest expense=$2,000,000*10%*(1-40%)=120000
adjusted net income=$500,000-$120,000=$380,000
new common stock=$6,000,000-$2,000,000=$4,000,000
adjusted return on equity=$380,000/$4,000,000=9.50%
