Mammoth Pictures Inc is considering a project that will requ

Mammoth Pictures Inc. is considering a project that will require $600,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 35%. what will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $155,000 O 16.8% 14.3% 10.1% 12.6% O Determine what the project\'s ROE will be if its EBIT is $55,000. When calculating the tax effects, assume that Mammoth Pictures Inc. as a whole will have a large, positive income this year 0-48% 0-54% 0-60% 0-72% Mammoth Pictures Inc. is also considering financing the project with 50% equity and 50% debt. The interest rate on the company\'s debt will be 13%. what will be the project\'s ROE if it produces an EBIT of $155,000? O o o 25.1% 18.8% 20.1% 23.8% What will be the project\'s ROE if it produces an EBIT of-$55,000 and it finances 50% of the project with equity and 50% with debt? when calculating the tax effects, assume that Mammoth Pictures Inc. as a whole will have a large, positive income this year -23.5% -25.5% -20.4% -18.4% the expected ROE, the probability of a large loss, and The use of financial leverage consequently the risk borne by stockholders. The greater the firm\'s chance of bankruptcy, the its optimal debt ratio will be. manager is more likely to use debt in an effort to boost profits.

Solution

Question 1: ROE = Net Income/ Total equity

Net Income = EBIT*(1-tax rate) = 155,000*(1-0.35) = 100,750

Total equity = Total assets = 600,000

ROE = 100,750/600,000 = 0.1679 =0.168 =16.8% (Option A)

Question 2: ROE = Net Income/Total equity

Net Income = -55,000*(1-0.35) =-35,750

ROE = -35,750/600,000 = -0.0596 = -5.96 = -6.0% (Roubnded) (Option C)

Question 3: EBIT = 155,000 , Interest = 0.13*300,000 = 39,000, EBIT = 155,000 - 39,000 = 116,000

Net Income = 116,000*(1-0.35) = 75,400

ROE = 75,400/300,000 = 0.251 = 25.1% (Option A)

Question 4: EBIT = -55,000 , Interest = 0.13*300,000 = 39,000, EBIT = -55,000 - 39,000 = 94,000

Net Income = -94,000*(1-0.35) = -61,100

ROE = -61,100/300,000 = -0.204 = -20.4% (Option C)

he use of financial leverage Increases the expected ROE, Increase the probability of a large loss, and consequently Increase the risk borne by stockholders. The greater the firm\'s chance of bankruptcy the higher its optimal debt ratio will be. An aggressive manager is more likely to use debt in an effort to boost profits.