Solved Question: A firm reports net income of $433,550.00 for 2013

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Solved Question:

A firm reports net income of $433,550.00 for 2013. The firm has a dividend payout ratio of 24.00%. The firm currently has $988,150.00 in debt and $1,650,600.00 in shareholder equity.
The firm pays 6.00% annual interest on their outstanding debt.

Based on the interest rate on debt, how much more interest will the firm pay in 2014? (Assume that all new debt is issued at first of the year)

(The firm pays 6.00% annual interest on their outstanding debt.)

Answer Format: Currency: Round to: 2 decimal places.

Answer:

The solution is based on the assumption that debt-equity ratio of the firm remains constant.

Given the net income of the firm =$433,550.

Dividend payout ratio=24%.

Assumed that debt and equity given are those at the beginning of the year.

Debt of the firm =$988,150.

Share holder equity=$1,650,600.

Annual interest=6%.

Retained earnings of 2013 =$433,550 *(1-.24)

=$433,550 * .76

=$329,498.

Given debt equity ratio of the firm =$988,150/$1650,600

=0.59866.

Increase in equity due to retained earnings in 2013 =$1,650,600.+$329,498.

=$1,980,098.

To maintain debt equity ratio additional debt taken = $1,980,098.* 0.59866.- $988,150.

=1185407.63 -$988,150.

=$197,257.63.

Assuming the debt is taken at the start of the year, additional interest the firm will pay=$197,257.63.*6%

=$11,835.45797 rounded to $11,835.46.

 

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