Mr. Agirich has provided the following information and ratios for the Aggie Farm

Question

Mr. Agirich has provided the following information and ratios for the Aggie Farms 20X0 operations:

         Average Total Assets    = $840,000

         Average Total Liabilities     = $395,000

         Net Farm Income before taxes = $74,800

         Interest Paid and accrued    = $26,000

         Income Taxes Paid = $9,000

Ra = Net Farm Income before tax + Interest/Average Farm Assets

               Assets=Debt + Equity

Based on this information, what is the projected Rate of Return on Equity after taxes, for Aggie Farms in 20X1? (Assume that the tax rate, t is 15% and the Rate of Return on Assets before taxes, Ra , will continue as reflected for 20X0 and that the future cost of debt, i, will be 10%. Use the equation presented in class to calculate the projected r. Use the information above to calculate Ra . Remember that Net Farm Income before taxes is from the Income statement and is after interest.

12-3

What is the projected Ra for Aggie Farms in 20X1, if Mr. Agirich projects Ra to be 5%? Keep everything else the same as before.

The projected Rate of Return on Equity after taxes is _______________?

5%

10%

0.5%

None of the above

Explanation / Answer

Answer a Assets = Debt + Equity Hence Equity = Assets - Debt = $840000 - $395000 = $445000 Net farm income after taxes = Net farm Income before taxes - Income tax @15% = $74800 - $11220 = $63580 Projected rate of return on Equity after taxes = Net Farm Income after taxes / Equity = $63580 / $445000 = 14.29% Answer b Rate of return on assets before taxes (Ra) = (Net farm income before tax + Interest) / Average Farm Assets Rate of return on assets before taxes (Ra) = ($74800 + $26000) / $840000 = 12% If Agririch projects Ra to be 5% , then Projected rate of return on equity after taxes will be as under Rate of return on assets before taxes (Ra) = (Net farm income before tax + Interest) / Average Farm Assets Assume net farm income before tax be X 0.05 = (X + $26000) / $840000 $42000 = X + $26000 X = $42000 - $26000 = $16000 Net farm income before tax = $16000 Net farm income after taxes = Net farm Income before taxes - Income tax @15% = $16000 - $2400 = $13600 Projected rate of return on Equity after taxes = Net Farm Income after taxes / Equity = $13600 / $445000 = 3.06% The answer is none of the above.

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