Question

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $19 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 25%. The CFO has estimated next year's EBIT for three possible states of the world: $5.8 million with a 0.2 probability, $2.8 million with a 0.5 probability, and $800,000 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. Debt/Capital ratio is 0.

Answer 1

Answer:

Debt/Capital ratio 0% $19 million Equity $0 million Debt $0 Interest |(R-ER)^2 Probability (P) EBIT $5.80 TAX at 25% p*(R-ER)^2 EBT ROE ('R) Possible states Interest R P R ER ЕВT EAT $0 $5.80 $1.45 $4.35 4.58% 1.4024% 0.20 22.89% 11.84% 0.2805% 1 0.00% $2.80 $0 $2.80 $0.70 $2.10 11.05% 5.53% 0.0000% 2. 0.50 0.0000% | $0.80 $0 $0.80 $0.20 $0.60 Expected ROE (ER) = 0.30 3.16% 0.95% -7,89% 0.6233% 3 0.1870% 11.05% 0.4675% Variance Standard deviation 6.84% CV 0.62 Jael