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FINANCIAL LEVERAGE EFFECTS The Neal Company wants to estimate next year's return on equity (ROE) under different...

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Finance

FINANCIAL LEVERAGE EFFECTS

The Neal Company wants to estimate next year's return on equity(ROE) under different financial leverage ratios. Neal's totalcapital is $16 million, it currently uses only common equity, ithas no future plans to use preferred stock in its capitalstructure, and its federal-plus-state tax rate is 40%. The CFO hasestimated next year's EBIT for three possible states of the world:$4.6 million with a 0.2 probability, $1.5 million with a 0.5probability, and $0.6 million with a 0.3 probability. CalculateNeal's expected ROE, standard deviation, and coefficient ofvariation for each of the following debt-to-capital ratios. Do notround intermediate calculations. Round your answers to two decimalplaces at the end of the calculations.

Debt/Capital ratio is 0.

RÔE =%
σ =%
CV =

Debt/Capital ratio is 10%, interest rate is 9%.

RÔE =%
σ =%
CV =

Debt/Capital ratio is 50%, interest rate is 11%.

RÔE =%
σ =%
CV =

Debt/Capital ratio is 60%, interest rate is 14%.

RÔE =%
σ =%
CV =

Answer & Explanation Solved by verified expert
4.1 Ratings (740 Votes)
DebtCapital ratio is 0 The value of ROE standard deviation and and coefficient of variation is arrived as follows State Probability of State A EBIT Interest EBITInterest1Tax Rate Equity 16000000 016000000 ROE B AB Variance 1 02 4600000 0 2760000 16000000 1725 345 000213 2 05 1500000 0 900000 16000000 563 281 000009 3 03 600000 0 360000 16000000 225 068 000066 RE 694 Variance 000287 Standard Deviation 0054 Coefficient of Variation RE 077 Tabular Representation as Required in Question RE 694 536 CV 077 DebtCapital    See Answer
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