Answer:
a. Basic earning power (BEP) = 16.63%
b. Return on equity (ROE) = 26.67%
c. Return on invested capital (ROIC) = 16.87%
Explanation:
From the question, we have the following:
Net income = $384,000
ROA = Return on Asset = 10%
Interest expense = $126,720
Accounts payable and accruals = $1,000,000
Tax rate = 25% = 0.25
Common equity finance percentage = 60%
Debt finance percentage = 40%
From the above, we have:
Total assets = Net income / ROA = $384,000 / 10% = $3,840,000
Net total assets = Total assets - Accounts payable and accruals = $3,840,000 - $1,000,000 = $2,840,000
Common equity = Net total assets * Common equity finance percentage = $2,400,000 * 60% = $1,440,000
Debt = Net total assets * Debt finance percentage = $2,400,000 * 40% = $960,000
Earning before tax = Net income / (1 - Tax rate) = $384,000 / (1 - 0.25) = $384,000 / 0.75 = $512,000
Earning before interest and tax = EBIT = Earning before tax + Interest expense = $512,000 + $126,720 = $638,720
We then proceed as follows:
a. Calculation of basic earning power (BEP)
This can be calculated using the following formula:
BEP = EBIT / Total assets = $638,720 / $3,840,000 = 0.166333333333333 = 0.1663, or 16.63%
b. Calculation of return on equity (ROE)
This can be calculated using the following formula:
ROE = Net income / Common equity = $384,000 / $1,440,000 = 0.266666666666667 = 0.2667, or 26.67%.
c. Calculation of return on invested capital (ROIC)
This can be calculated using the following formula:
ROIC = (EBIT * (1 - Tax rate)) / (Common equity + Debt) = ($638,720 * (1 - 0.25)) / ($1,440,000 + $960,000) = ($638,720 * 0.75)) / $2,840,000 = $479,040 / $2,840,000 = 0.168676056338028 = 0.1687, or 16.87%
