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What is Financial leverage and What Are Its Effects?
Solution
1./
EXPECTED RETURN ON EQUITY = (NET INCOME AFTER TAX / NUMBER OF
COMMON STOCK) * 100
AS HERE THERE IS NO TAX SO THE BEFORE TAX CASH FLOW IS THE NET INCOME
AFTER TAX.
SO EXPECTED RETURN ON EQUITY = [$2100000 / ($490000 * $50)] * 100
= ($2100000 / $24500000) * 100
= 8.57%
---------------------------------------------------------------------------------------------------------------------
-----------------------------------------------
NET INCOME BEFORE TAX = $2100000
LESS INTEREST (12250000 * 6%) = ($735000)
NET INCOME AFTER INTEREST = $1365000
AS THERE IS NO TAX SO THE INCOME AFTER INTEREST IS THE INCOME AFTER
TAX.
REMAINNING NUMBER OF COMMON STOCK (490000 - 245000) = 245000
EXPECTED RETURN ON EQUITY = [($1365000 / (245000 * $50)] * 100
= ($1365000 / $12250000) * 100
= 11.14%

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What is Financial leverage and What Are Its Effects Solution1.pdf

  • 1. What is Financial leverage and What Are Its Effects? Solution 1./ EXPECTED RETURN ON EQUITY = (NET INCOME AFTER TAX / NUMBER OF COMMON STOCK) * 100 AS HERE THERE IS NO TAX SO THE BEFORE TAX CASH FLOW IS THE NET INCOME AFTER TAX. SO EXPECTED RETURN ON EQUITY = [$2100000 / ($490000 * $50)] * 100 = ($2100000 / $24500000) * 100 = 8.57% --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------- NET INCOME BEFORE TAX = $2100000 LESS INTEREST (12250000 * 6%) = ($735000) NET INCOME AFTER INTEREST = $1365000 AS THERE IS NO TAX SO THE INCOME AFTER INTEREST IS THE INCOME AFTER TAX. REMAINNING NUMBER OF COMMON STOCK (490000 - 245000) = 245000 EXPECTED RETURN ON EQUITY = [($1365000 / (245000 * $50)] * 100 = ($1365000 / $12250000) * 100 = 11.14%