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Date Posted: 20:04:37 07/01/02 Mon
Author: Dr. D.
Subject: Re: QUIZ QUESTION #6
In reply to: ANONYMOUS 's message, "QUIZ QUESTION #6" on 18:33:20 07/01/02 Mon

>IN QUESTION #6 ON QUIZ 2, HOW DO YOU GET DR=60% FROM
>1/(1-DR).

I'll show it two ways. The first step is to calculate the Equity Multiplier:

Remember - ROE=15% and ROA=9%;
So, since ROE=ROA x Equity Multiplier,
15% = 9% x EM ==> EM = 15/9 or 5/3

Next. convert the EM to the Debt ratio:

Since EM = 1/(1-DR) ==> 5/3 = 1/(1-DR)
so cross multiplying gets us:
5/3 x (1-DR) = 1

5/3 - (5/3 x DR) = 1

5/3 - 1 = 5/3 DR
2/3 = 5/3 DR
DR = (2/3) / (5/3) = 2/5, or 40%

Alternately, Since EM = A/E, Set Assets to 5 and equity to 3. Since "Balance Sheets Balance", Assets must equal 2

So, D/A = 2/5 = 40%

Hope this helps.

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