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Assessment Of Return On Equity For A Firm

Question

GeKay Inc is levered with debt/value of 0.4. Analysts are forecasting GeKay’s EPS for next year at $2 and a return on equity (ROE) of 18%.  

Butler Inc is a firm in the same industry and has the same operating earnings as GeKay but Butler is all-equity financed with a beta of 0.75. Both firms have a marginal tax rate of 35%. The risk-free rate is 5% and the market risk premium is 8%.

Circle the best answer below:

A.  Butler’s ROE for next year is likely to be greater than 18%
B.  Butler’s ROE for next year is likely to be less than 18%
C.  We have insufficient information to infer anything about Butler’s likely ROE.
D.  Since they are both in the same industry and are in the same (marginal) tax bracket, their ROE numbers for next year are likely to be equal
E.  The ROE numbers are likely to be equal but not for the reason (D) above

Summary

The question belongs to Finance and it discusses about assessing a company’s return on equity with given information and choosing the right answer from the given options.

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