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1 January, 07:39

How would Skaters World, Inc.'s return on equity (ROE) be different if the company were to issue $200,000 of 10% bonds instead of $200,000 in stock? Assume income before interest and taxes is estimated to be $100,000, income taxes are 35% and stockholders' equity is initially $300,000.

a. ROE would be the same.

b. ROE would be higher with bonds.

c. ROE would be lower with bonds.

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  1. 1 January, 08:05
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    B) ROE would be higher with bonds.

    Explanation:

    If the company issued $200,000 bonds with 10% interest rate, the return on equity (ROE) would be:

    EBIT = $100,000

    interests = ($20,000)

    net income = (ebit - interest) x (1 - 35%) = ($100,000 - $20,000) x 65% = $80,000 x 65% = $52,000

    ROE = $52,000 / $300,000 = 17.3%

    If the company issued $200,000 in new stocks, the return on equity (ROE) would be:

    EBIT = $100,000

    net income = ebit x (1 - 35%) = $100,000 x 65% = $65,000

    ROE = $65,000 / $500,000 = 13%
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