Question

Assume that a farmer has $345,543 in Total Assets and $234,432 in Net Worth, faces

22.5% income tax rate, and 38.5% consumption rate. Further, assume that the rate-of-
return on assets is 15.5%.
(i) What is the interest rate for this farm if the growth rate is 10.5%?
(ii) Now assume that the rate-of-return on assets is 20%, interest rate is 5%, and
income tax and consumption rates are as before. What leverage ratio allows for
obtaining expected firm growth of 15%?

Answer 1

To calculate the interest rate for the farm's growth rate of 10.5%, use (Growth Rate / Net Worth) + Consumption Rate. To calculate the leverage ratio for obtaining an expected firm growth of 15%, use (Interest Rate - Rate of Return on Assets) / (Income Tax Rate + Consumption Rate).

Step-by-step explanation:

To calculate the interest rate for the farm's growth rate of 10.5%, we can use the formula:

Interest Rate = (Growth Rate / Net Worth) + Consumption Rate

Plugging in the values, the interest rate would be:

(10.5% / $234,432) + 38.5% = 43.02%

For the second part of the question, to calculate the leverage ratio for obtaining an expected firm growth of 15%, we can use the formula:

Leverage Ratio = (Interest Rate - Rate of Return on Assets) / (Income Tax Rate + Consumption Rate)

Plugging in the values, the leverage ratio would be:

(5% - 20%) / (22.5% + 38.5%) = -0.07