Question

Candy Games Inc. expects the following numbers for next year:Sales: $59,000,000Costs: $45,000,000 (excluding depreciation)Depreciation: $5,000,000Interest: 2,000,000Tax rate: 29%Total assets: $110,000,000Debt-to-equity ratio: 2What is the expected return on equity?

Answer 1

Answer: First, we need to calculate the amount of debt and equity based on the debt-to-equity ratio:

Debt-to-equity ratio = Debt / Equity

2 = Debt / Equity

Equity = Debt / 2

Equity = ($110,000,000 - Debt) / 2

Next, we can calculate the amount of interest paid on the debt:

Interest = $2,000,000

We can calculate the amount of earnings before interest and taxes (EBIT):

EBIT = Sales - Costs - Depreciation

EBIT = $59,000,000 - $45,000,000 - $5,000,000

EBIT = $9,000,000

We can then calculate the amount of earnings after taxes (EAT):

EAT = EBIT x (1 - Tax rate)

EAT = $9,000,000 x (1 - 0.29)

EAT = $6,390,000

Finally, we can calculate the return on equity (ROE):

ROE = EAT / Equity

ROE = $6,390,000 / (($110,000,000 - Debt) / 2)

Since we don't have a specific value for the amount of debt, we cannot calculate the exact ROE. However, we can say that as the amount of debt increases, the ROE will decrease because there will be more interest payments to be made, which will reduce the earnings available for equity holders.

Enjoy!