Broward Manufacturing recently reported the following information: Net income $384,000 ROA 10% Interest expense $126,720 Accounts payable and accruals $1,000,000 Broward's tax rate is 25%. Broward finances with only debt and common equity, so it has no preferred stock. 40% of its total invested capital is debt, and 60% of its total invested capital is common equity. Calculate its basic earning power (BEP), its return on equity (ROE), and its return on invested capital (ROIC). Do not round intermediate calculations. Round your answers to two decimal places.

a. Basic earning power (BEP) = 16.63%

b. Return on equity (ROE) = 26.67%

c. Return on invested capital (ROIC) = 16.87%

Explanation:

From the question, we have the following:

Net income = $384,000

ROA = Return on Asset = 10%

Interest expense = $126,720

Accounts payable and accruals = $1,000,000

Tax rate = 25% = 0.25

Common equity finance percentage = 60%

Debt finance percentage = 40%

From the above, we have:

Total assets = Net income / ROA = $384,000 / 10% = $3,840,000

Net total assets = Total assets - Accounts payable and accruals = $3,840,000 - $1,000,000 = $2,840,000

Common equity = Net total assets * Common equity finance percentage = $2,400,000 * 60% = $1,440,000

Debt = Net total assets * Debt finance percentage = $2,400,000 * 40% = $960,000

Earning before tax = Net income / (1 - Tax rate) = $384,000 / (1 - 0.25) = $384,000 / 0.75 = $512,000

Earning before interest and tax = EBIT = Earning before tax + Interest expense = $512,000 + $126,720 = $638,720

We then proceed as follows:

a. Calculation of basic earning power (BEP)

This can be calculated using the following formula:

BEP = EBIT / Total assets = $638,720 / $3,840,000 = 0.166333333333333 = 0.1663, or 16.63%

b. Calculation of return on equity (ROE)

This can be calculated using the following formula:

ROE = Net income / Common equity = $384,000 / $1,440,000 = 0.266666666666667 = 0.2667, or 26.67%.

c. Calculation of return on invested capital (ROIC)

This can be calculated using the following formula:

ROIC = (EBIT * (1 - Tax rate)) / (Common equity + Debt) = ($638,720 * (1 - 0.25)) / ($1,440,000 + $960,000) = ($638,720 * 0.75)) / $2,840,000 =  $479,040 / $2,840,000 = 0.168676056338028 = 0.1687, or 16.87%

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