Question

Assignment 13 - Capital Structure and Leverage 3. The effect of financial leverage on ROE Aa Aa 3 Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Mammoth Pictures Inc. is considering a project that will require $500,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 40%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $160,000? 21.1% 19.2% O 13.4% 15.4% Determine what the project's ROE will be if its EBIT is - $40,000. When calculating the tax effects, assume that Mammoth Pictures Inc. as a whole will have a large, positive income this year. 0 -5.5% O -4.3% O -5.3% -4.8% Mammoth Pictures Inc. is also considering financing the project with 50% equity and 50% debt. The interest rate on the company's debt will be 10%. What will be the project's ROE if it produces an EBIT of $160,000? 22.7% 32.4% 37.3% 24.3% O O

Answer 1

Partiolas Amoont ) 160,00 tess: Interest Eapense E2,50,00x 10 కరూ dess Tan S4ons ర EA E ROE= 81,0023 x loo 3a.4% Particubr Amt EBIT kess: Interent £apen E BT 6రం Adbt Tak Saunas EAE (SoruingsAoiabe 39,oo ি ) a 6,0us (pty EIS.6% 39,000x10G ROE s0000 Iruatmeut

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