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 maximizes 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             1 000                            600

Debt                     -                                400

Total assets 1 000                              1 000

EBIT                 400                                400

Interest            -                                    (44)

Income before tax 400                     356

Tax                 (112)                            (99.7)

Net income 288                                256.3

Required:

Calculate the ROE and ROA for the Companies A and B respectively. 

 Compare and discuss the ROA and ROE of the two companies as calculated above. 

What happens if the ROA is lower than the interest charge (negative gearing)? 

Answer rating: 100% (QA)

Calculation of ROE Return on Equity and ROA Return on Assets 1 Company A ROE Net Income Equity ROA N... View the full answer