Question 10.5: Assume that the profit before interest and tax was 20% highe...
Assume that the profit before interest and tax was 20% higher for each company in Example 10.4 than stated. How would this affect the return on owners’ equity?
The revised profit available to the shareholders of each company in the first year of operations will be:
| X Ltd | Y Ltd | |
| $ | $ | |
| Operating profit | 60,000 | 60,000 |
| Interest expense | 20,000 | 10,000 |
| Profit before taxation | 40,000 | 50,000 |
| Taxation (say 30%) | 12,000 | 15,000 |
| Profit available to ordinary shareholders | 28,000 | 35,000 |
The return on shareholders’ funds for each company will now be:
X ltd = \frac{28,000}{100,000} × 100 = 28%
Y Ltd = \frac{35,000}{200,000} × 100 = 17.5%
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