Question: The Damon Company wishes to calculate next year s ROE under

The Damon Company wishes to calculate next year’s ROE under different leverage ratios. Damon’s total assets are $14 million, and its marginal tax rate is 40 percent. The company can estimate next year’s earnings before interest and taxes for three possible states of the world: $4.2 million with a 0.2 probability, $2.8 million with a 0.5 probability and $700,000 with a 0.3 probability. Calculate Damon’s expected ROE, standard deviation, and coefficient of variation for each of the debt-to-total-assets ratios in the following list and evaluate the results. ROE = (Net income)/(Common equity).
Leverage (Debt/Assets) Interest Rate
0% .......... —
10 ........... 9%
50 ........... 11
60 ........... 14

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