Question

Carefree Company provides the following selected financial information for Year 2000: Sales $17,633 Net Income $405 Interest expense before taxes $245 Preferred stock dividend $27 Tax rate 35% Average total assets $17917.5 Average preferred equity $348 Average common equity $5901.5 (a) Calculate the ROA for Year 2000. (b) Calculate the ROCE for Year 2000. (c) Calculate the amount of net income to common shareholders derived from the excess return on creditors' capital, the excess return on preferred shareholders' capital, and the return on common shareholders' capital. (d) Did debt work to the advantage of the common shareholders in Year 2000? How about preferred stock, did it work to the advantage of the common shareholders in Year 2000?

Answer 1

Sales	Given	17,633.00
EBIT	Given	405.00
Interest	Given	245.00
EBT	EBIT - Interest	160.00
Tax 35%	160*35%	56.00
EAT	EBT - Tax	104.00
Preference dividend	Given	27.00
Earnings for Equity shareholders	EAT - Pref dividend	77.00
Assets	Given	17,917.50
Return on assets = EAT / Assets	104/17917.5*100	0.58%
Capital employed
Preferred stock	348.00
Equity	5,901.50
Capital employed	6,249.50
Return on capital employed	EAT/Capital employed
	104/6249.5	1.66%
Net income to equity shareholders	As above	77.00

Debt always works to the advantage of equity shareholders, as there is tax shield effect available on interest payment.

However, the tax shield is not available for preference dividend.