Question

Western Gas & Electric Co. is considering a project that will require $550,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 30%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $150,000? 19.1% 13.4% 12.4% 16.2% Determine what the project's ROE will be if its EBIT is -$60,000. When calculating the tax effects, assume that Western Gas & Electric Co. as a whole will have a large, positive income this year. -6.8% -7.6% -8.4% -6.5% Western Gas & Electric Co. is also considering financing the project with 50% equity and 50% debt. The interest rate on the company's debt will be 12%. What will be the project's ROE if it produces an EBIT of $150,000? 29.8% 34.3% 22.4% 23.8% What will be the project's ROE if it produces an EBIT of -$60,000 and it finances 50% of the project with equity and 50% with debt? When calculating the tax effects, assume that Western Gas & Electric Co. as a whole will have a large, positive income this year. -24.9% -22.5% -28.4% -23.7%

Answer 1

PART A:

ROE = EBIT(1-T) / Equity

= $ 150,000(1-0.3) / $ 550,000

= $ 150,000* 0.7 / $ 550,000

= $ 105,000 / $ 550,000

= 0.1909 i.e 19.1%

Part B:

ROE = EBIT(1-T) / Equity

= - $ 60,000(1-0.3) / $ 550,000

= - $ 60,000* 0.7 / $ 550,000

= - $ 42,000 / $ 550,000

= -0.0764 i.e 7.64%

PART C:

Particulars	Amount	Formula
EBIT	$ 1,50,000.00	Given
Int	$    33,000.00	Debt * Int Rate
EBT	$ 1,17,000.00	EBIT - Int
Tax	$    35,100.00	EBT * Tax Rate
EAT	$    81,900.00	EBT - Tax
Equity	$ 2,75,000.00	Assets * 50%
ROE	0.2978	EAT / Equity

Part D:

Particulars	Amount	Formula
EBIT	$ -60,000.00	Given
Int	$    33,000.00	Debt * Int Rate
EBT	$ -93,000.00	EBIT - Int
Tax	$ -27,900.00	EBT * Tax Rate
EAT	$ -65,100.00	EBT - Tax
Equity	$ 2,75,000.00	Assets * 50%
ROE	-0.2367	EAT / Equity