Question

During the previous year, Leveraged Inc. paid $100 million of interest expense, and its average rate of interest for the year was 8%. The company's ROE is 18.4%, and it pays no dividends. Estimate next year's interest expense assuming that interest rates will fall by 34% and the company keeps a constant equity multiplier, Calculate next year's estimated interest expense

Answer 1

$67214400

Step-by-step explanation:

Average rate of interest = 8% = 0.08

Amount paid by leveraged Inc ( previous year ) = $100 million

Growth rate retention = 1 ( since company pays no dividend )

ROE = 18.4% = 0.184

Determine next year's estimated interest expense

Given that Interest rates will fall by 34%

interest expenses = $100,000,000

estimated Interest rate = 0.34

First step : calculate total debt

= interest expense / interest rate

= 100,000,000 / 0.08 = $1,250,000,000

next determine the growth rate

= ROE * growth rate retention = 0.184 * 1 = 0.184

next determine next year's debt

= Total debt * ( 1 + 0.184 )

= 1,250,000,000 * 1.0184 = $1,273,000,000

next determine Interest rate for next year

= interest rate - ( Interest rate * estimated interest rate )

= 0.08 - ( 0.34 * 0.08 ) = 0.0528 = 5.28%

Finally determine next year's estimated interest expense

= 5.28% * $1,273,000,000

= 0.0528 * 1,273,000,000 = $67214400