Question

The Amer Company has the following characteristics: Sales = $1,000, Total assets = $1,000. Total debt/Total assets =35%, Basic Earning Power (BEP) ratio = 20%, Tax rate = 40%, Interest rate on total debt = 4.57%. What is Amer's ROE?

Answer 1

Answer:

ROE  = 16.98%

Explanation:

The question is to determine Amer Company's Return on Equity

The following steps are taken:

1) The Total Debt ÷ Total Assets = 35%

It means Total Debt ÷  1000= 0.35

Meaning 0.35 x $1,000 = $350 and this is the total debt

2) Calculate Interest on debt

Interest on debt = Interest rate on total debt x total debt

= 4.57% x $350 = $16

3) Now calculate the Net Income from Earnings before Interest and Tax

Earnings before Interest and tax = $200

less interest                                       $16

Earnings Before Tax                       $184

Subtract tax (40% of EBT)                 $73.6

Net income                                       $110.4

4) Calculate the Return on Equity

= Net income/ Shareholders' Equity

= $110.4/ ($1,000-$300)

= 16.98%