Question

During the previous​ year, Leveraged Inc. paid

​$120

million of interest​ expense, and its average rate of interest for the year was

8.0​%.

The​ company's ROE is

11.1​%,

and it pays no dividends. Estimate next​ year's interest expense assuming that interest rates will fall by

16​%

and the company keeps a constant equity multiplier.

Next​ year's estimated interest expense is

Answer 1

As question provided that the company keeps a constant equity multiplier, it means that no change in the value of Equity therefore next year estimated interest expense -

Average interest rate of return for current year = 8%

Interest Expense for the current year = $ 120 millions

Total debt = $ 120 millions / 8 %

= $ 1500 millions

if interest rate fall by = 16 %

then rate of interest = 8 - 16%

= 6.72 %

Therefore next year's estimated interest expense = 6.72 %

As condition provided that no change in equity multiplier therefore interest expense in next year ( estimated) -

= $ 1500 millions * 6.72 %

= $ 100. 8 millions