A firm begins the year with $25,000 in assets, of which $10,000 is depreciable e

Question

A firm begins the year with $25,000 in assets, of which $10,000 is depreciable equipment, and $16,000 in owners' equity. Its debt carries an interest rate of 5%. Revenue Total operating costs 22,500 Deprecation rate 10% Investment in new equipment2,200 (this does not get depreciated this year) Profits tax rate Dividend payout ratio 40% 30,000 25% What is the coverage ratio? What are its before- and after-tax profits for the year and ROE? How much does it pay in dividends? What are retained earnings? How much cash is added to the balance sheet at the end of the year? Can you see the difficulty with the new balance sheet?

Explanation / Answer

Debt = total assets - owners equity = 25000 - 16000 = 9000

Interest = 9000 * 0.05 = 450

Income statement for the Year

Question - 1 ........... Interest coverage ratio = EBIT / Interest = 6500 / 450 = 14.44 times

Question - 2 ........... EBT = 6050 and EAT = 4537.5

ROE = Return on Equity = EAT / Equity * 100 = 4537.5 / 16000 * 100 = 28.36 %

Question - 3 ......... Dividend paid = 4537.5 * 40% = 1815

Retained earnings = 4537.5 * 60% = 2722.5

Question - 4

Cash added = PAT + Depreciation - Dividend - New equipment

= 4537.5 + 1000 - 1815 - 2200 = 1522.5

Revenue 30000 (-) Operating costs 22500 (-) Depreciation 1000 EBIT 6500 (-) Interest 450 EBT 6050 (-) Tax 1512.5 Profit after tax 4537.5

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