use excel to answer

roblem #1: Changing Debt & Interest Rates

• They have an operating income of 1,500,000 SAR
• They have assets of 7,500,000 SAR
• The Tax rate is 22.5%
• They currently do not have any debt but are considering the following scenarios:

Scenario A

No debt

Scenario B

Interest rate 9.5%

B1 increase debt to 2,500,000 SAR

B2 increase debt to 5,000,000 SAR

Scenario C

Interest rate 12.5%

B1 increase debt to 2,500,000 SAR

B2 increase debt to 5,000,000 SAR

Based on the above information, address the following questions:

Compare Scenario A (no debt) to Scenario B (increasing debt 9.5% interest rate)

• What impact does increasing the debt have on the taxable income?

1. What impact does increasing the debt have on the net income?
2. What impact does increasing the debt have on the dollar return to investors?

Compare Scenario B (increasing debt 9.5% interest rate) to Scenario C (increasing debt 12.5% interest rate)

• What impact does the higher interest rate have on the taxable income?

1. What impact does the higher interest rate have on the net income?
2. What impact does the higher interest rate have on the dollar return to investors?

Key points

• How does debt financing influence ROE?

1. Increasing debt can have what impact on the amount of tax paid?
2. A higher interest rate can have what effect on the level of taxes paid?
3. A higher interest rate can have what effect on the dollar return to investors?
4. How does a higher interest rate affect ROE?