Company S is a very small company in terms of market capitalization, has total assets of $2 million financed 40 percent with debt and 60 percent with equity capital. The cost of debt is 7 percent before taxes. The cost of equity capital is 12 percent. The company has a net income of $200,000 and a tax rate of 30 percent. Calculate the residual income for this company. (show work)
$ 16,800
| Step-1:Calculation of Wighted Average Cost of Capital (WACC) | ||||
| WACC | = | (Wd*Kd)+(We*Ke) | ||
| = | (0.40*0.049)+(0.60*0.12) | |||
| = | 9.16% | |||
| Where, | ||||
| Kd | = | Before tax cost of debt*(1- Tax Rate) | ||
| = | 7%*(1-0.30) | |||
| = | 0.049 | |||
| Wd | = | Weight of debt | ||
| We | = | Weight of equity | ||
| Ke | = | Cost of Equity | ||
| Step-2:Calculation of residual income | ||||
| Residual Income | = | Net Income | - | (Total assets * WACC) |
| = | $ 2,00,000.00 | - | (2000000*9.16%) | |
| = | $ 2,00,000.00 | - | $ 1,83,200.00 | |
| = | $ 16,800.00 |
Get Answers For Free
Most questions answered within 1 hours.