The cost of capital is the rate of return required by investors in the companys securities. It
Question:
The cost of capital is the rate of return required by investors in the company’s securities. It thus follows that a capital structure should derive the lowest cost of capital which maximizes the value of the company. Consider the following extract with financial information of Company A & Company B:
Company B Company B
R’000 R’000
Equity 1 000 600
Debt - 400
Total assets 1 000 1 000
EBIT 400 400
Interest - (44)
Income before tax 400 356
Tax (112) (99.7)
Net income 288 256.3
Required:
Calculate the ROE and ROA for the Companies A and B respectively.
Compare and discuss the ROA and ROE of the two companies as calculated above.
What happens if the ROA is lower than the interest charge (negative gearing)?
Smith and Roberson Business Law
ISBN: 978-0538473637
15th Edition
Authors: Richard A. Mann, Barry S. Roberts