Rose Corporation”s condensed balance sheet for Year 2 is reproduced below:
Assets
Current assets
$ 250,000
Noncurrent assets
1,750,000
Total assets
$2,000,000
Liabilities and Equity
Current liabilities
$ 200,000
Noncurrent liabilities (8% bonds)
675,000
Common stockholders” equity
1,125,000
Total liabilities and equity
$2,000,000
Additional Information:
1. Net income for Year 2 is $157,500.
2. Income tax rate is 50%.
3. Amounts for total assets and shareholders” equity are the same for Years 1 and 2.
4. All assets and current liabilities are considered to be operating.
Required:
a. Determine whether leverage (from long-term debt) benefits Rose”s shareholders. (Hint: Examine ROCE with and without leverage.)
b. Compute Rose”s NOPAT and RNOA (use ending NOA).
c. Demonstrate the favorable effect of leverage given the disaggregation of ROCE and your answer to part (b).
