Question

Baker Industries' net income is $21,000, its interest expense is $6,000, and its tax rate is 25%. Its notes payable equals $24,000, long-term debt equals $70,000, and common equity equals $260,000. The firm finances with only debt and common equity, so it has no preferred stock. What are the firm's ROE and ROIC?

Answer 1

Baker Industries has a Return on Equity (ROE) of 8.08% and a Return on Invested Capital (ROIC) of 7.20% calculated using the given financial information and appropriate formulas.

Step-by-step explanation:

To calculate the Return on Equity (ROE) for Baker Industries, we use the formula ROE = Net Income / Shareholder's Equity. From the given information, the net income is $21,000, and the common equity (shareholder's equity) is $260,000. Thus, ROE = $21,000 / $260,000 = 0.0808 or 8.08%.

To calculate the Return on Invested Capital (ROIC), we need to find the after-tax operating income (NOPAT) and the total capital invested. NOPAT is calculated by adding back net interest expense after taxes to the net income. The interest expense is $6,000, and the tax rate is 25%, so the after-tax interest expense is $6,000 * (1 - 0.25) = $4,500. NOPAT = Net Income + After-tax interest expense = $21,000 + $4,500 = $25,500. Total capital invested is the sum of debt and equity, which is the notes payable of $24,000 plus long-term debt of $70,000 and common equity of $260,000, totaling $354,000. Therefore, ROIC = NOPAT / Total Capital = $25,500 / $354,000 = 0.0720 or 7.20%.