MAC2602 Assignment 2 2022 Answers

QUESTION 1


TABLE 1 (Option)


Funded by equity only


Total assets R600 million:

Equity R600 million (R400 m + R200 m)

Debt R0 million
Rm
Earnings before interest & tax (EBIT) (115 x 1.10) 126.50

Interest 0.0

Profit before tax 126.50

Income tax expense @ 28% (35.42)

(a) Net profit 91.08




(b) Return on assets (ROA) = Net profit/Total Assets
= R91.08m/R600m x 100% = 15.18%


(c) Return on equity (ROE) = Net profit/Total Equity
= R91.08/R600m x 100% = 15.18%

, TABLE 2 (Option 2)




50% equity and 50% debt funding


Total assets R600 million:

Equity R500 million (R400 m + R100 m)

Debt R100 million

Rm
Earnings before interest & tax (EBIT) (115 x 1.10) 126.50

Interest (9)

Profit before tax 117.50

Income tax expense @ 28% (32.90)

(a) Net profit 84.60




(b) Return on assets (ROA) = Net profit/Total Assets
= R84.60m/R600m x 100% = 14.10%


(c) Return on equity (ROE) = Net profit/Total Equity
= R84.60/R500m x 100% = 16.92%




d) Give a short explanation why the inclusion of debt funding (option 2) increases the
return on equity (ROE).

• The returns for equity holders (measured in the Return on Equity) increase when
expansion is funded by debt. This is called the leverage effect
• Since equity is equal to assets minus total debt, a company can decrease its equity
as a percentage of its assets by increasing its debt.
• Assets, the numerator of the financial-leverage figure; increases, so the overall
financial-leverage number rises, boosting ROE
= R91.08m/R600m x 100