Jimbob Co.is considering ways to finance a planned business expansion after which the company will have $150,000 in earnings before interest and income taxes.The income tax rate is 30%.One alternative being considered is to issue new common shares.If this alternative is chosen the company's common shareholders' equity is expected to average $1,000,000.What will be the return on common shareholders' equity if this alternative is taken?
A) 0%.
B) 10.5%.
C) 15%.
D) 30%.

Question

Quizplus · Accepted Answer

To calculate the return on common shareholders' equity, we need to use the following formula:

Return on Common Shareholders' Equity = Earnings Available to Common Shareholders / Average Common Shareholders' Equity

First, we need to calculate the earnings available to common shareholders by subtracting the income tax from earnings before interest and income taxes:

Earnings Available to Common Shareholders = Earnings Before Interest and Income Taxes x (1 - Tax Rate)
Earnings Available to Common Shareholders = $150,000 x (1 - 0.3)
Earnings Available to Common Shareholders = $105,000

Next, we need to use the given information that if new common shares are issued, the average common shareholders' equity will be $1,000,000.

Now we can calculate the return on common shareholders' equity:

Return on Common Shareholders' Equity = $105,000 / $1,000,000
Return on Common Shareholders' Equity = 0.105 or 10.5%

Therefore, the best choice is B, with an explanation that the return on common shareholders' equity will be 10.5% if the company decides to issue new common shares to finance its planned business expansion.

Jimbob CoIs Considering Ways to Finance a Planned Business Expansion After