Question $5(10$ Marks$)$

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 maximises 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 $1000600$

Debt $-400$

Total assets $10001000$

EBIT $400400$

Interest $-(44)$

Income before tax $400356$

Tax $(112)(99\mathrm{.}7)$

Net income $288256\mathrm{.}3$

Required:

$5\mathrm{.}1.$ Calculate the ROE and ROA for the Companies A and B respectively. $(5)$

$5\mathrm{.}2.$ Compare and discuss the ROA and ROE of the two companies as calculated in $(5\mathrm{.}1)$

above. $(3)$

$5\mathrm{.}3.$ What happens if the ROA is lower than the interest charge $($negative gearing$)?(2)$