Question

In: Accounting

Consider the following data for the XYZ Company: Assets: $150 million Equity: $90 million Sales: $75...

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.

Expert 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%

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