Last year Jandik Corp.had $295,000 of assets (which is equal to its total invested capital),$18,750 of net income,and a debt-to-total-capital ratio of 37%.Now suppose the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%.Sales,total assets,and total invested capital will not be affected,but interest expenses would increase.However,the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged.By how much would the change in the capital structure improve the ROE?
A)2.13%
B)2.35%
C)2.58%
D)2.84%
E)3.12%

Question

Quizplus · Accepted Answer

The correct answer is A.The change in the capital structure would increase the ROE by 2.13%. This is because the increase in debt would increase the financial leverage, which would in turn increase the ROE. The increase in interest expense would be offset by the better cost controls, so the net income would remain unchanged.

Last Year Jandik Corp