Question

Problem 19-13 A firm has an ROE of 4.8 % , a debt-to-equity ratio of 0.6, and a tax rate of 35% and pays an interest rate of 8% on its debt. What is its operating ROA? (Do not round intermediate calculations. Round your answer to 2 deci mal places.) ROA %

Answer 1

ROE = (Net Income / Equity) = 0.048, Debt to Equity = 0.6, Tax Rate = t = 35 %, Interest Rate = 8%

Let the debt be $ 0.6k and equity be $ k (such that the debt to equity ratio remains at 0.6)

ROE = Net Income / Equity = 0.048

Net Income = 0.048 x k

Profit Before Tax (PBT) = Net Income / (1-Tax Rate) = [0.048k/(1-0.35)]

Interest Expense = Interest Rate x Debt = 0.08 x 0.6k = 0.048k

Operating Profit = PBT + Interest Expense = [0.048k/(1-0.35)] + 0.048k

Asset = Equity + Debt = k + 0.6k = 1.6k

Operating ROA = [{0.048k/0.65}+ 0.048k] / 1.6k = 0.076154 or 7.6154 % ~ 7.61 %