4. Collect Yourselt Urdlogy Ptpsicions (CYUP) prowdes the toowing dats CEBIT I E

Question

4. Collect Yourselt Urdlogy Ptpsicions (CYUP) prowdes the toowing dats CEBIT I Eamings Before Interest and Taioes EBIT Assets 1,080,000 5180,000 40% A, (6 Polres) It's nets are currerity 100% egitymenced(no debt), what is CYUP'S current RDE ,0 70, cco (6 Points) Trheyreplace some EqRywith 25% debt finendn9-stan interest rate of 8%, what i* CYUP's ROE? 8. C. (6 Points) What advice would you give CYUP regardng the addtion of debt with a higher interest cost than their current RCE to their captd structure?

Explanation / Answer

a)

Net income =EBIT - taxes

= 180000 - 180000 * 0.4

= 108000

since 100% of assets if equity , equity = 1080000

ROE = netincome/equity

= 108000/1080000

= 10%

b)

interest = total assets * weight of debt * interest rate

= 1080000 * 25% * 8%

= 21600

net income = (EBIT - interest) * (1 -taxrate)

= (108000 - 21600) * (1-40%)

= 51840

equity = 1080000 * 75% = 810000

ROE = 51840/810000 = 6.4%

c)

their current return is 10% but by borrowing they are reducing return on equity, so,it better to have current capital structure

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