You are considering a stock investment in one of two firms (AllDebt, Inc., and A
ID: 1171670 • Letter: Y
Question
You are considering a stock investment in one of two firms (AllDebt, Inc., and AllEquity, Inc.), both of which operate in the same industry and have identical operating income of $9.50 million. AllDebt, Inc., finances its $30 million in assets with $29 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. AllEquity, Inc., finances its $30 million in assets with no debt and $30 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. Calculate the income available to pay the asset funders (the debt holders and stockholders) and resulting return on asset-funders' investment for the two firms. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.) AllDebt AllEquity Income available for asset funders $ m $ m Return on asset-funders' investment % %
Explanation / Answer
No Equity
No Debt
Net income
4.62 Million
6.65 Million
Return on assets
15.40%
22.17%
Workings
No Equity
No Debt
Operating income
$9.50 Million
$9.50 Million
Less : Interest on Debt [ $29 Million x 10% ]
2.90 Million
-
Income Before Tax
$6.60 Million
$9.50 Million
Less : Tax at 30%
1.98 Million
2.85 Million
Net Income available to pay the asset funders
4.62 Million
6.65 Million
Return on assets
No Equity = [ $4.62 Million / $30 Million ] x 100 = 15.40%
No Debt = [ $6.65 Million / $30 Million ] x 100 = 22.17%
No Equity
No Debt
Net income
4.62 Million
6.65 Million
Return on assets
15.40%
22.17%
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