CS Executive · Corporate Accounting and Financial Management · Capital Structure
A firm has total long-term capital of ₹10,00,000 with equity ₹6,00,000 and 10% debt ₹4,00,000. It earns EBIT of ₹2,00,000 and the tax rate is 25%. Ignoring any other factors, what is the return on equity (net profit/equity)?
Return on equity is 20%. Interest is ₹40,000, so profit before tax is ₹1,60,000. After 25% tax of ₹40,000, profit after tax is ₹1,20,000. Dividing by equity of ₹6,00,000 gives 20%.
- A20%
- B22.5%Correct
- C25%
- D18.75%
Explanation
Interest = 10% of 4,00,000 = 40,000. EBT = 2,00,000 − 40,000 = 1,60,000. Tax at 25% = 40,000, so PAT = 1,20,000. ROE = 1,20,000/6,00,000 = 20%. Check: this equals 20%, so option A is correct; 22.5% would result from ignoring tax on interest incorrectly.
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