Consider the following data for the XYZ Company Assets 150 m

Consider the following data for the XYZ Company:

Assets: $150 million

Equity: $90 million

Sales: $75 million

EBIT: $26 million

Profit (bt) $20 million

Profit (at) $15 million

a) How much debt does XYZ have in its capital structure?

b) How much interest is XYZ paying on this debt? What is the interest rate?

c) How much in taxes is XYZ paying? What is the tax rate?

d) What is XYZ company\'s current ROE?

e) Suppose, XYZ could save $10 million in labor costs per year by purchasing a state-

of-the-art, new machine. However, the new machine will cost $30 million. If XYZ

buys the new machine by borrowing $30 million. What will the new ROE?

[Assume they can borrow the $30 million at the same interest rate as the existing

borrowed money. Please calculate the new ROE under these conditions assuming the

tax rate remains unchanged. Assume all else remains unchanged.]

f) Suppose, after careful consideration of the additional debt suggested in part f), XYZ

decides to purchase the new machine by selling common stock (equity) to raise the $30

million. Please calculate the ROE under these conditions assuming all else remains the

same.

Solution

a Accounting Equation Particulars Amount Assets    150.00 Equity      90.00 Debt(150-90)      60.00 b Particulars Amount EBIT      26.00 Less: Interest(Bal.fig)         6.00 PBT      20.00 Debt(from above)      60.00 % of Interest(6/60) 10.00% c Particulars Amount PBT      20.00 Less: Tax(20-15)         5.00 PAT      15.00 Tax Rate(5/20) 25.00% d Particulars Amount Net Income(PAT)      15.00 Equity      90.00 ROE(15/90) 17% e Particulars Amount EBIT(26+10)      36.00 Less: Interest(6+30*10%)         9.00 PBT      27.00 Less: Tax(27*25%)         6.75 PAT      20.25 Accounting Equation Particulars Amount Assets(150+30(machine cost))    180.00 Equity      90.00 Debt(180-90(60+30 borrowing))      90.00 Particulars Amount Net Income(PAT)      20.25 Equity      90.00 ROE(20.25/90) 23% f Particulars Amount EBIT(26+10)      36.00 Less: Interest(6)         6.00 PBT      30.00 Less: Tax(30*25%)         7.50 PAT      22.50 Accounting Equation Particulars Amount Assets(150+30(machine cost))    180.00 Equity      60.00 Debt(180-60)    120.00 Particulars Amount Net Income(PAT)      22.50 Equity      60.00 ROE(22.5/60) 38%