Question

Please show the work

Allied Manufacturing has total assets of $4 million, financed with 50% debt and 50% equity. The cost of debt is 6% before taxes and the cost of equity capital is 11%. The company has EBIT of $300,000 and a tax rate of 30%. Estimate Allied’s residual income. (Enter your answer to the nearest $1,000. Leave the $ sign off. In other words, if your answer is $55,550, enter 56 for your answer. If your answer is negative, be sure to include a minus sign, like -56)

Answer 1

Answer : Residual Income is (- 4).

Calculation of Residual Income :

Residual Income = Earning Before income and taxes ( Operating Income ) - (Weighted Average cost of capital * Average operating Asset)

Calculation of WACC

WACC = (Cost of after tax Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

= [6% * (1 - 0.30) * 0.50] + [11% * 0.50]

= 2.1% + 5.5%

= 7.6%

Residual Income = Earning Before income and taxes ( Operating Income ) - (Weighted Average cost of capital * Average operating Asset)

= 300,000 - (7.6% * 4,000,000)

= 300,000 - 304,000

= (-4000) or (-4)(Rounded off to nearest 1000)