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Unformatted text preview: Solutions to Ch. 4 Homework Problems Financial Statement Analysis 416 Known data: TA = $1,000,000; Int. rate = 8%; T = 40%; BEP = 0.2 = EBIT/Total assets, so EBIT = 0.2($1,000,000) = $200,000; D/A = 0.5 = 50%, so Equity = $500,000. D/A = 0% D/A = 50% EBIT $200,000 $200,000 Interest 40,000 * EBT $200,000 $160,000 Tax (40%) 80,000 64,000 NI $120,000 $ 96,000 ROE = Equity NI = $1,000,000 $120,000 = 12% $500,000 $96,000 = 19.2% Difference in ROE = 19.2% 12.0% = 7.2%. *If D/A = 50%, then half of the assets are financed by debt, so Debt = $500,000. At an 8% interest rate, INT = $40,000. 417 Statement a is correct. Refer to the solution setup for Problem 416 and think about it this way: (1) Adding assets will not affect common equity if the assets are financed with debt. (2) Adding assets will cause expected EBIT to increase by the amount EBIT = BEP(added assets). (3) Interest expense will increase by the amount Int. rate(added assets). (4) Pretax income will rise by the amount (added assets)(BEP Int. rate). Assuming BEP > Int. rate, if pretax income increases so will net income. (5) If expected net income increases but common equity is held constant, then the expected ROE will also increase. Note that if Int. rate > BEP, then adding assets financed by debt would lower net income and thus the ROE. Therefore, Statement a is trueif assets financed by debt are added, and if the expected BEP on those assets exceeds the interest rate on debt, then the firms ROE will increase. Statements b, c, and d are false, because the BEP ratio uses EBIT, which is calculated before the effects of taxes or interest charges are felt. Of course, Statement e is also false. 418 TA = $5,000,000,000; T = 40%; EBIT/TA = 10%; ROA = 5%; TIE ? . 000 , 000 , 500 $ EBIT 10 . ,000 $5,000,000 EBIT = = . 000 , 000 , 250 $ NI 05 . ,000 $5,000,000 NI = = Now use the income statement format to determine interest so you can calculate the firms TIE ratio....
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This note was uploaded on 04/05/2009 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.
 Spring '07
 Chen
 Interest

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