FINANCIAL LEVERAGE EFFECTS
Response to the following problem:
The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $42 million with a 0 2 probability, $2 8 million with a 0 5 probability, and $700,000 with a 0 3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios; then evaluate the results:
|
Debt/Capital
Ratio
|
Interest
Rate
|
|
0%
|
-
|
|
10
|
9%
|
|
50
|
11
|
|
60
|
14
|