EXERCISE 8–1 Rose Corporation’s condensed balance sheet for Year 2 is reproduced below:

Assets Current assets................................... $ 250,000 Noncurrent assets ............................. 1,750,000 Total assets....................................... $2,000,000 Liabilities and Equity Current liabilities .............................. $ 200,000 Noncurrent liabilities (8% bonds) ..... 675,000 Common stockholders’ equity............ 1,125,000 Total liabilities and equity................. $2,000,000 Additional Information:

1. Net income for Year 2 is $157,500.

2. Income tax rate is 50%.

3. Amounts for total assets and shareholders’ equity are the same for Years 1 and 2.

4. All assets and current liabilities are considered to be operating.

Required:

a. Determine whether leverage (from long-term debt) benefits Rose’s shareholders. (Hint: Examine ROCE with and without leverage.)

b. Compute Rose’s NOPAT and RNOA (use ending NOA).

c. Demonstrate the favorable effect of leverage given the disaggregation of ROCE and your answer to part (b).