Question

Flowers by Irene Inc. is a small company and is considering a project that will require $550,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 25%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $155,000?

a. 14.80%
b. 12.68%
c. 21.14%
d. 23.25%

Answer 1

To find the ROE for Flowers by Irene Inc., calculate the net income by deducting taxes from EBIT and divide by shareholder's equity. The calculated ROE is 21.14%.

Step-by-step explanation:

To calculate the Return on Equity (ROE) for the project at Flowers by Irene Inc., we start with the formula ROE = Net Income / Shareholder's Equity. Since the company is financed with 100% equity, the equity is the initial project investment of $550,000. We first need to calculate the net income by subtracting taxes from EBIT (earnings before interest and taxes).

The EBIT is given as $155,000, and with a tax rate of 25%, the taxes amount to $155,000 × 0.25 = $38,750. Thus, Net Income = EBIT - Taxes = $155,000 - $38,750 = $116,250.

Now, we calculate the ROE: ROE = Net Income / Shareholder's Equity = $116,250 / $550,000 = 0.2114, or 21.14%.

So, the correct option is c. 21.14%.