Question

Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Sombra Corp. is considering a project that will require $600,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 35%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $145,000

Answer 1

ROE = 15.7%

Step-by-step explanation:

Return on Equity (R.O.E). Equity capital is the capital provided by the ordinary shareholders. So the ROE measures, in percentage, the amount made as profit for every one Dollar of equity capital invested . That is, how much return is earned (in %) on every dollar of equity capital invested.

It is calculated as follows:

ROE= (Profit/equity capital )× 100

Profit = EBIT - Tax = 145,000- (35%×145,000)=94,250

ROE = 94,250/600,000× 100 =15.7%

ROE = 15.7%