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A firm has a ROE of 3%, a debt-to-equity ratio of
A firm has a ROE of 3%, a debt-to-equity ratio of .5, and a tax rate of 20% and pays an interest rate of 6% on its debt. What is its operating ROA?
Expert Solution
Computation of Operating ROA:
ROE = ((ROA + (ROA - Interest Rate)*(Debt/Equity))*(1-Tax Rate)
3% = ((ROA +(ROA - 6%)*0.5)*(1-20%)
3% = ((ROA + (0.5*ROA) - 0.03)*80%
3% / 80% = (ROA + (0.5*ROA) - 0.03
3.75% = 1.5 ROA - 0.03
3.75%+0.03 = 1.5 ROA
6.75% = 1.5 ROA
ROA = 4.50%
So, its Operating ROA is 4.50%. If you have any doubt you can ask me through comment box.
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