Question

Duffert Industries has total assets of $940,000 and total current liabilities (consisting only of accounts payable and accruals) of $130,000. Duffert finances using only long-term debt and common equity. The interest rate on its debt is 8% and its tax rate is 40%. The firm's basic earning power ratio is 14% and its debt-to capital rate is 40%. What are Duffert's ROE and ROIC? Do not round your intermediate calculations.

Answer 1

Duffert's return on equity (ROE) is 16.2% and the return on invested capital (ROIC) is 24.4%.

Step-by-step explanation:

To find Duffert's return on equity (ROE), we need to calculate net income and divide it by average equity. Net income can be found using the basic earning power ratio and total assets. The basic earning power ratio is calculated as EBIT/Total assets. Given that the basic earning power ratio is 14%, we can calculate EBIT (earnings before interest and taxes) as follows: EBIT = Basic earning power ratio × Total assets = 0.14 × $940,000 = $131,600. To find average equity, we can subtract total liabilities from total assets. Average equity = Total assets - Total liabilities = $940,000 - $130,000 = $810,000. Finally, the ROE is calculated as Net income / Average equity = $131,600 / $810,000 = 0.162 = 16.2%.

To find Duffert's return on invested capital (ROIC), we need to calculate the after-tax operating income and divide it by the capital employed. After-tax operating income can be found by multiplying the EBIT by (1 - Tax rate). After-tax operating income = EBIT × (1 - Tax rate) = $131,600 × (1 - 0.4) = $78,960. Capital employed is the sum of long-term debt and common equity. Capital employed = Long-term debt + Common equity = ($940,000 - $130,000) × 0.4 = $324,000. Finally, the ROIC is calculated as After-tax operating income / Capital employed = $78,960 / $324,000 = 0.244 = 24.4%.