Financial Statements, Cash Flow, and Taxes - Solutions7

Financial - Tot al PV of EVA2006 = \$3,063,840(0.12 0.04 = \$38,298,000 61 Assume that your company is 60 percent equity financed(40 percent debt

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Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions Page 61 of 73 Pages Total PV of EVA 2006 = \$3,063,840 / (0.12 - 0.04) = \$38,298,000 61. Assume that your company is 60 percent equity financed (40 percent debt financed). Given the following information, calculate the return on equity (ROE). Data Amount EBIT \$6,000 Sales \$35,000 Interest Rate 0.06 Dividend payout ratio 40% Total assets turnover 0.70 x Tax rate 40% A. 9.20% B. 9.50% C. 9.40% D. 9.30% * E. 9.60% TAT = 0.75 = Sales / TA TA = Sales / TAT = \$35,000 / 0.70 = \$50,000 Debt = (\$50,000)*(.40) = \$20,000 Equity = (\$50,000)*(.60) = \$30,000 Interest Expense = (\$20,000)*(0.06) = \$1,200 EBIT \$6,000 Interest -\$1,200 EBT \$4,800 Taxes -\$1,920 Net Income \$2,880 ROE = \$2,880 / \$30,000 = 9.60% 62. We discussed in class how the return on equity for a levered firm can be a function of the return on assets of an equivalent unlevered firm, a leverage effect, and a tax shelter effect. Assume that a firm starts out as an all equity firm with \$10,000,000 of common equity, \$10,000,000 of assets, and a return on assets (ROA) of 14 percent. Also assume that management makes the decision to issue \$2,000,000 of debt (the firm’s cost of debt is 8 percent), and to then use the proceeds to buy back \$2,000,000 of common equity. Based on this information, and assuming that the firm’s tax rate is 40 percent, determine what the return on equity (ROE) will be after the buy back. A. 15.05% B. 17.55%

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Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions Page 62 of 73 Pages C. 12.55% * D. 16.30% E. 13.80% Debty / Equity = \$2,000,000 / \$8,000,000 = .25 ROA = 14.0% (Given) r D = 8.0% (Given) After-tax r D = (8.0%)*(1-.40) = 4.,80% Interest Expense = (\$2,000,000)*(.08) = \$160,000 Debt does create a leverage and a tax shelter effect, so ROE = ROA (unlevered) + Leverage Effect + Tax Shelter Effect ROE = 0.14 + (0.14 - 0.08)*(.25) + (0.08 - 0.048)*(.25) ROE = 0.14 + 0.015 + 0.008 = 16.30% Alternatively, ROA = NI / TA NI = (ROA)*(TA) = (0.14)*(\$10,000,000) = \$1,400,000 Work backwards up through income statement to get EBIT: EBIT \$2,333,333 Interest - \$ 0 EBT \$2,333,333 Taxes - \$ 933,333 Net Income \$1,400,000 Now consider the interest payment: Interest Expense = (\$2,000,000)*(0.08) = \$160,000 EBIT \$2,333,333 Interest - \$ 160,000 EBT \$2,173,333 Taxes - \$ 869,333 Net Income \$1,304,000 NEW ROE = \$1,304,000 / \$8,000,000 = 16.30% 63. Assume that Firm A is an all-equity firm with total assets of \$2,000 and the following distribution of EBIT for the coming year:
Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions Page 63 of 73 Pages Economy Firm A (Unlevered) Bad Average Good Probability 30.00% 40.00% 30.00% EBIT \$200.00 \$240.00 \$280.00 Interest \$0.00 \$0.00 \$0.00 EBT \$200.00 \$240.00 \$280.00 Taxes (40%) -\$80.00 -\$96.00 -\$112.00 Net Income \$120.00

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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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Financial - Tot al PV of EVA2006 = \$3,063,840(0.12 0.04 = \$38,298,000 61 Assume that your company is 60 percent equity financed(40 percent debt

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