Problem 13-7 Financial leverage effects The Neal Company wants to estimate next
ID: 2735567 • Letter: P
Question
Problem 13-7
Financial leverage effects
The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $20 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 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.6 million with a 0.2 probability, $3.4 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 at the end of the calculations.
Debt/Capital ratio is 0.
Debt/Capital ratio is 10%, interest rate is 9%.
Debt/Capital ratio is 50%, interest rate is 11%.
Debt/Capital ratio is 60%, interest rate is 14%.
PLEASE DO ALL THE QUESTIONS!!!
Problem 13-7
Financial leverage effects
The Neal Company wants to estimate next year's return on equity (ROE) under different leverage ratios. Neal's total capital is $20 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 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.6 million with a 0.2 probability, $3.4 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 at the end of the calculations.
Debt/Capital ratio is 0.
RÔE = % = % CV =Debt/Capital ratio is 10%, interest rate is 9%.
RÔE = % = % CV =Debt/Capital ratio is 50%, interest rate is 11%.
RÔE = % = % CV =Debt/Capital ratio is 60%, interest rate is 14%.
RÔE = % = % CV =Explanation / Answer
Solution.
1. Debt/Capital ratio is 0.
ROE = 3,060,000 / 20,000,000 = 15.3%
5,600,000.00 0.20 1,120,000.00 3,400,000.00 0.50 1,700,000.00 800,000.00 0.30 240,000.00 Total 3,060,000.00