You have the following information about two firms, Debt Free, Inc. and Debt Spr

Question

You have the following information about two firms, Debt Free, Inc. and Debt Spree, Inc. Both firms have the same prospects for sales and EBIT, and both have the same level of assets, tax rate and borrowing rate. They differ in their use of debt financing. Scenario Bad year Normal year Good year Sales EBIT 200 12 275 38 380 46 Total assets Tax rate Debt Equity Borrowing rate Debt Free Debt Spree 250 250 35 % 35 % 150 250 100 16 % 16 % Calculate the interest expense for each firm: Interest expense for Debt Free Interest expense for Debt Spree $ 24 o Calculate the following items for each firm for each scenario (bad year, normal year, good year); return on assets (ROA), net profit, and return on equity (ROE). (Use a minus sign to indicate negative answers. Round your answers to 2 decimal places.) Debt Free Debt Spree Scenario ROA Net Profit ROE ROA Net Profit ROE Bad year 3.12 % 7.80 3.12 % -3.12% -7.80 o -7.80 0% Normal year 9.88 % 24.70 9.88 % 3.640% 9.10 9.10 O% Good year 11.96% 29.90 11.96 % 5.72 % 14.30 14.30 %

Explanation / Answer

Return on total asset = EBIT/TOtal assets =

Bad year Normal Good Debt free EBIT 12 38 46 Total asset 250 250 250 ROA = EBIT/total assets x 100 = 4.80% 15.20% 18.40% debt spree 12 38 46 Total asset 250 250 250 4.80% 15.20% 18.40% Please provide feedback…. Thanks in advance

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