Assume a firm has $45 million in operating profit. The firm’s tax rate is 40%. W

Question

Assume a firm has $45 million in operating profit. The firm’s tax rate is 40%. What is the tax shield of the firm’s $38 million in debt that charges a 10% interest rate?

Which of the following is TRUE regarding Company ABC given the following information?
Current Assets = $250
Fixed Assets =$70
Current Liabilities = $110
Long term Debt = $90
Sales = $330
Net Income = $60

Given the following, calculate WACC for company XYZ:

Debt: $600 M

Equity: $700 M

Cost on Debt: 5.0%

Cost on Equity: 11.0%

Tax Rate: 40.0%

Explanation / Answer

1) The correct option is debt to equity ratio is 0.80

Shareholders Equity = Total assets - Current liabilities- Long term Debt

= Current assets + fixed assets - current liabilities - Long term debt

= 250 + 70 - 110 - 90

= 120

Current ratio = current assets / current liabilities = 250/110

= 2.27

Asset turnover = sales / total assets

   = sales / (current assets + fixed assets)    = 330/ (250+70)

   = 1.03

Debt to equity = Long term debt / shareholders equity = 90/120 = 0.75

But considering the current portion of debt which will come under current liabilities , debt to equity will be slightly > 0.75 approx 0.80

Return on equity = net income / shareholders equity = 60/120 = 50%

2)

WACC = wD * (1-T) * rD + wE * rE

wD , wE are weights of Debt and Equity respectively in total capital

rD , rE are cost of debt and equity respectively

T is the tax rate = 40% = 0.40

wD = Debt / ( Debt + Equity)    = 600/ (600+700) = 0.4615

wE= Equity / ( Debt + Equity)    = 700/ (600+700) = 0.5385

WACC = 0.4615 * (1-0.40) * 5% + 0.5385 * 11%

= 7.3076

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