The Neal Company wants to estimate next year\'s return on equity (ROE) under dif

Question

The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $12 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: $5.6 million with a 0.2 probability, $2.2 million with a 0.5 probability, and $400,000 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.

Explanation / Answer

ROE =( EBIT-Interest on DEbt)*(1-0.40) /Neal's Equity capital * 100

Since debt to capital ratio is missing in Question cannot solve for Interest On Debt

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Debt = 12*debt-to-capital ratios

Interest on Debt = 12*debt-to-capital ratios*Interest rate

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Neal's expected ROE = Sum of Column-3

S.D. = Square root of Sum of Column-4

Coeffecient of Variation = S.D / Mean * 100

= Neal's expected ROE/S.D * 100

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