Homework Answers
a) Calculation of return on equity
Total assets = 1 million Euro
Return on Asset = Net Income / Total Assets
8% = x / 1 million Euro , by solving we get,
Net income of 80,000 Euro.
Debt portion in total asset = 90% of 1 million Euro. = 9,00,000 Euro.
Hence, Equity = 1,00,000 Euro.
ROE = Net Income / Shareholder's Equity
= 80,000 Euro / 1,00,000 Euro
= 80%
b) Calculation of return on equity after increase in interest rates
Debt portion in total asset = 90% of 1 million Euro. = 9,00,000 Euro.
Hence, Equity = 1,00,000 Euro.
The net income of 80,000 Euro was arrived after deducting interest payment @ 5% on 9,00,000 Euro from EBIT of the company, after increase of interest rate @10%, the interest charged will be doubled, therefore extra interest cost = 5% of 9,00,000 Euro = 45,000 Euro.
Therefore, net income = 80,000 - 45,000 Euro
= 35,000 Euro.
ROE = Net Income / Shareholder's Equity
Return on equity will be 35,000 Euro / 1,00,000
= 3.5 or 35%
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