Question

SWC plc is a grocery chain. Its reported debt to capital ratio is 20%, and return on capital is 8%, on a book value of invested capital of £500 million. If the operating lease expense in the current year is £40 million, the present value of lease commitments is £400 million, the tax rate is 20%, and the pre-tax cost of debt is 5%, estimate the company's adjusted debt to capital and return on capital. (5 marks) Rich Plc generated £100 million in net income and £80 million in Free cash flow to equity (FCFE) in the latest year. The company paid out £70m in dividends. The book value of equity is £800 million, it has debt of £200 million and cash of £50 million. If the tax rate is 20%, what is the a. Equity reinvestment rate? (2.5 marks) b. Expected growth in net income? (2.5 marks)

Answer 1

QUESTION 4	SWC
	DEBT EQUITY RATIO	20: 100
	Return on Capital	8.00%
	Capital	500	Million
	Operating Lease	40	Million
	Present Cost of Debt	5.00%
	tax rate	20.00%
	DEBT EQUITY RATIO	20: 100
	Capital	500	Million
	debt will be	(20/100)*500
a	DEBT	100	Million
	Return on Capital	8% of 500 million
b	Return on Capital	40	Million
	cost of debt	5% of 100
c	cost of debt	5	million
	Adjusted Debt to Capital
	Return on Capital
	sales	95	calculated back
	cost of debt	5	ref c
	Operating Lease	40	given
	Net Income	50
	tax	10	@ 20 %
	Net Income Post tax	40
	Return on Capital	40.00
	net income – dividend
	--------------------------------
	Debt + equity
	' (50-40)/(100+500)
	1.67%
	Since the ratio is less than 2% SWC should rethink the operations
QUESTION 5	Rich PLC
	Net Income	100	million
	Free Cash flow	80	million
	book value of Equity	800	million
	Dividend	70	million
	Debt	200	million
	Cash	50	million
	Tax	20.00%
	Equity Reinvestment Rate
	Dividend / book value of equity	%
	8.75%
	Expected Growth Rate in Net Income
	Free Cash flow	50	million
	tax	10
	Free Cash flow	40
	'80-40/100
	79.60