The Neal Company wants to estimate next year\'s return on equity (ROE) under dif
ID: 2621590 • Letter: T
Question
The Neal Company wants to estimate next year's return on equity (ROE) under different 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 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.5 million with a 0.2 probability, $3.5 million with a 0.5 probability, and $600,000 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.
R
Explanation / Answer
Debt/Capital ratio is 0.
Debt = 0 and Capital = $13,000,000
State
Ps
1
2
3
0.2
0.5
0.3
EBIT
4600000
2,500,000
300,000
(EBIT rdD)(1 T)
2760000
$1,500,000
$180,000
Return
on
Equity
10.43
Variance
0.005
Standard Deviation
Coefficient of Variation
ROES
PS(ROE)
0.21
0.12
0.01
RE =
0.0707
0.68
0.0425
0.0577
0.0042
0.1043
PS(ROES RE)2
0.0022
0.0001
0.0027
0.0050
7.07 %
Debt/Capital ratio is 10%, interest rate is 9%.
Debt =1,300,000 and Capital = $11,700,000
State
Ps
1
2
3
0.2
0.5
0.3
EBIT
4600000
2,500,000
300,000
(EBIT rdD)(1 T)
2689800
1429800
109800
Return
on
Equity
10.99
Variance
0.0059
Standard Deviation
Coefficient of Variation
ROES
PS(ROE)
0.23
0.12
0.01
RE =
0.07681
0.70
0.0460
0.0611
0.0028
0.1099
PS(ROES RE)2
0.00288
0.00005
0.00297
0.00590
7.68 %...
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