Universal Inc. is in the process of acquiring another business. In light of the acquisition,shareholders are currently re-evaluating the appropriateness of the firm's capital structure (the types of and relative levels of debt and equity). The two proposals being contemplated are detailed below:
Requirements:
a. Calculate the estimated return on equity (ROE)under the two proposals. (ROE ~ net income after taxes / market value of equity; net income after taxes = (EBIT - interest on long-term debt)× (I - tax rate).)
b. Which proposal will generate the higher estimated ROE?
Definitions:
Volume Variance
An assessment of the impact of production or sales volume differences on a company's revenue or expenses, relative to budgeted amounts.
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