195k views
3 votes
How would Skaters World, Inc.'s return on equity (ROE) be different if the company were to issue $200,000 of 10% bonds instead of $200,000 in stock? Assume income before interest and taxes is estimated to be $100,000, income taxes are 35% and stockholders' equity is initially $300,000.

a. ROE would be the same.
b. ROE would be higher with bonds.
c. ROE would be lower with bonds.

1 Answer

3 votes

Answer:

B) ROE would be higher with bonds.

Step-by-step explanation:

If the company issued $200,000 bonds with 10% interest rate, the return on equity (ROE) would be:

EBIT = $100,000

interests = ($20,000)

net income = (ebit - interest) x (1 - 35%) = ($100,000 - $20,000) x 65% = $80,000 x 65% = $52,000

ROE = $52,000 / $300,000 = 17.3%

If the company issued $200,000 in new stocks, the return on equity (ROE) would be:

EBIT = $100,000

net income = ebit x (1 - 35%) = $100,000 x 65% = $65,000

ROE = $65,000 / $500,000 = 13%

User Daniel Lin
by
7.9k points

No related questions found

Welcome to QAmmunity.org, where you can ask questions and receive answers from other members of our community.

9.4m questions

12.2m answers

Categories