Ohio Quarry, Inc. has $12,000,000 in assets. Its expected operating income (EBIT) is $2,000,000 and its income tax rate is 40%. If Ohio Quarry finances 20% of its total assets with debt capital, the pretax cost of funds is 10%. If the company finances 40% of its total assets with debt capital, the pretax cost of funds is 15%.
a) determine the rate of return on equity under the three different capital structures
debt ratio 0% 20% 40%
b) Which capital structure yields the highest expected ROE?
c) Determine the ROE under each of the three capital structures (o,20,40, percent debt ratios)
if expected EBIT decreases by 20%
d) Which capital structure yields the highest ROE calculated in part c?
e) Determine the percentage change in ROE under each of the three capital structures
(ie, debt ratios) as the result of a 20% decline in EBIT.
f) Based on the results in part e, which capital structure yields the highest variability
(ie risk) in ROE?
Computation in excel for you.