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1) Bird Enterprises has no debt
1) Bird Enterprises has no debt. Its current total value is $47.6 million. Assume the company sells $18.7 million in debt.
a) Ignoring taxes, what is the debt-equity ratio?
b) Assume the company's tax rate is 23 percent. What is the debt-equity ratio?
2) A company has $1,000,000 of debt and $3,000,000 of assets. The company's cost of debt is 4% and EBIT is $200,000. Assume there are no taxes. What is the company's ROE?
Expert Solution
1-a) Computation of the debt-equity ratio:-
Equity = Total value - Debt
= $47.6 - $18.7
= $28.9 million
Debt-equity ratio = Debt / Equity
= $18.7 / $28.9
= 0.65
b) Computation of the debt-equity ratio:-
Value of levered firm = Value of unlevered firm + (Debt * Tax rate)
= $47.6 + ($18.7 * 23%)
= $47.6 + $4.30
= $51.90
Equity = Value of levered firm - Debt
= $51.90 - $18.7
= $33.20
Debt-equity ratio = Debt / equity
= $18.7 / $33.20
= 0.56
2) Computation of the ROE:-
Net income = EBIT - Interest - Taxes
= $200,000 - ($1,000,000 * 4%) - 0
= $200,000 - $40,000 - 0
= $160,000
Total equity = Total assets - Total debt
= $3,000,000 - $1,000,000
= $2,000,000
ROE = Net income / Total equity
= $160,000 / $2,000,000
= 8.00%
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