Explanation:
The firm’s leverage = AE=E+DE=1+DE\frac{A}{E} = \frac{E + D}{E} = 1 + \frac{D}{E}EA=EE+D=1+ED =52=2.5= \frac{5}{2} = 2.5=25=2.5
ROE = (ROA × Leverage ratio) − [(Leverage ratio − 1) × cost of debt] = (0.10×2.5)−[(2.5−1)×0.03]=0.205(0.10 \times 2.5) - [(2.5 - 1) \times 0.03] = 0.205(0.10×2.5)−[(2.5−1)×0.03]=0.205 or $20.5%$
$20.5
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Q.3877 ABC Ltd. is a US-based food processing firm. The firm has a ROA of 10%, total assets equal to $5, equity capital equal to $2. The firm’s cost of debt is 3%. Calculate the firm’s ROE.
$5
$2
A
19.8
B
20.1
C
20.5
D
21.2
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