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Ohio Quarry Inc. has $13 million in assets. Its expected operating income (EBIT) is $5 million and its income tax rate is 40 percent. If Ohio Quarry finances 20 percent of its total assets with debt capital, the pretax cost of funds is 10 percent. If the company finances 40 percent of its total assets with debt capital, the pretax cost of funds is 15 percent. Round your answers to the questions below to two decimal places. Problem 1: Determine the rate of return on equity (ROE) under the three different capital structures (0, 20, and 40% debt ratios).
Problem 2: Determine the ROE under each of the three capital structures (0, 20, and 40% debt ratios) if expected EBIT decreases by 40 percent.
Problem 3: Determine the percentage change in ROE under each of the three capital structures (that is, debt ratios) as the result of a 40 percent decline in EBIT. Use the minus sign to enter a negative percentage change in ROE if necessary.
Northern purchased the entire business of Southern including all its assets and liabilities for $687,750. Below is information related to the two companies:
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