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Firm A and Firm B have debt-total asset ratios of 42% and 32% and returns on total assets of 7% and 12%, respectively
Firm A and Firm B have debt-total asset ratios of 42% and 32% and returns on total assets of 7% and 12%, respectively.
What is the return on equity for Firm A and Firm B? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
Expert Solution
Computation of Return on Equity:
Debt-Total Assets Ratio = Debt/Total Assets
For Firm A:
Debt = 0.42 * Total Assets
Total Assets = Debt+Equity
Total Equity = 0.58 * Total Assets
Return on Assets (ROA) = Net Income/Total Assets
Hence,
Net Income = 0.07*Total assets
Return on Equity (ROE) = Net Income/Total Equity
=0.07*Total Assets/ 0.58*Total Assets
Return on Equity (ROE) = 12.07%
For Firm B:
Debt = 0.32 * Total Assets
Total Assets = Debt+Equity
Total Equity = 0.68 * Total Assets
Return on Assets (ROA) = Net Income/Total Assets
Hence,
Net Income = 0.12*Total assets
Return on Equity (ROE) = Net Income/Total Equity
=0.12*Total Assets/ 0.68*Total Assets
Return on Equity (ROE) = 17.65%
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