Chapter13Solutions

Chapter13Solutions - Chapter 13 Problem Solutions 13-5 a LL...

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Unformatted text preview: Chapter 13 Problem Solutions 13-5 a. LL: D/TA = 30%. EBIT $4,000,000 Interest ($6,000,000 0.10) 600,000 EBT $3,400,000 Tax (40%) 1,360,000 Net income $2,040,000 Return on equity = $2,040,000/$14,000,000 = 14.6%. HL: D/TA = 50%. EBIT $4,000,000 Interest ($10,000,000 0.12) 1,200,000 EBT $2,800,000 Tax (40%) 1,120,000 Net income $1,680,000 Return on equity = $1,680,000/$10,000,000 = 16.8%. b. LL: D/TA = 60%. EBIT $4,000,000 Interest ($12,000,000 0.15) 1,800,000 EBT $2,200,000 Tax (40%) 880,000 Net income $1,320,000 Return on equity = $1,320,000/$8,000,000 = 16.5%. Although LLs return on equity is higher than it was at the 30% leverage ratio, it is lower than the 16.8% return of HL. Initially, as leverage is increased, the return on equity also increases. But, the interest rate rises when leverage is increased. Therefore, the return on equity will reach a maximum and then decline....
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Chapter13Solutions - Chapter 13 Problem Solutions 13-5 a LL...

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