Detailed Answer
Answer (A) is correct. The first step is to determine the amount of equity. If the debt-to-equity ratio is .6, the calculation is .6E + E = $20 million. Thus, E (equity) equals $12.5 million. Debt is therefore $7.5 million. At 9%, interest on $7.5 million of debt is $675,000. Earnings before taxes are $2,325,000 ($3,000,000 EBIT – $675,000 interest). At a 40% tax rate, taxes are $930,000, which leaves a net income of $1,395,000. Return on equity is calculated by dividing the $1,395,000 by the $12,500,000 of equity capital, giving an ROE of 11.16%.