Appendix A Solutions to Self-Test Questions and Problems A-21
the more money CMC retains and invests, the lower its average ROE will be.
We can determine the average ROE under different conditions as follows:
Old situation (with founder active and a 20% payout):
g! (1.0 " Payout ratio)(Average ROE)
12%! (1.0 " 0.2)(Average ROE)
Average ROE! 12%/0.8! 15% % rs! 14%
Note that the average ROE is 15%, whereas the marginal ROE is presumably
equal to 14%.
New situation (with founder retired and a 60% payout as explained in Part c:
g! 6%! (1.0 " 0.6)(ROE)
ROE! 6%/0.4! 15% % rs! 14%
This suggests that a new payout of 60% is appropriate and that the! rm is tak-
ing on investments down to the point at which marginal returns are equal to
the cost of capital. Note that if the 20% payout was maintained, the average
ROE would be only 7.5%, which would imply a marginal ROE far below the
14% cost of capital.
Chapter 15
The Calgary Company: Alternative Balance Sheets
Restricted
!40%"
Moderate
!50%"
Relaxed
!60%"
Current assets $1,200,000 $1,500,000 $1,800,000
Fixed assets 600,000 600,000 600,000
Total assets $1,800,000 $2,100,000 $ 2,400,000
Debt $ 900,000 $1,050,000 $1,200,000
Equity 900,000 1,050,000 1,200,000
Total liabilities and equity $1,800,000 $2,100,000 $ 2,400,000
The Calgary Company: Alternative Income Statements
Restricted Moderate Relaxed
Sales $3,000,000 $3,000,000 $3,000,000
EBIT 450,000 450,000 450,000
Interest (10%) 90,000 105,000 120,000
Earnings before taxes $ 360,000 $ 345,000 $ 330,000
Taxes (40%) 144,000 138,000 132,000
Net income $ 216,000 $ 207,000 $ 198,000
ROE 24.0% 19.7% 16.5%
a. and b.
Income Statements for Year Ended December 31, 2008 (Thousands of Dollars)
Vanderheiden Press Herrenhouse Publishing
a b a b
EBIT $ 30,000 $ 30,000 $ 30,000 $ 30,000
Interest 12,400 14,400 10,600 18,600
Taxable income $ 17,600 $ 15,600 $ 19,400 $ 11,400
Taxes (40%) 7,040 6,240 7,760 4,560
Net income $ 10,560 $ 9,360 $ 11,640 $ 6,840
Equity $100,000 $100,000 $100,000 $100,000
ROE 10.56% 9.36% 11.64% 6.84%
ST-2ST-2
ST-3ST-3
