Question

1. Based on the current market rates for bonds of Frenza, Nelo, and Lika, which of the following bonds do lenders believe has the highest risk level? 2. If Frenza decided to issue new bonds with a contract rate of 11%, would these new bonds be sold at a discount or premium based on the current market rate for Frenza bonds? 3. Frenza is planning an $160,000 expansion to launch a new product line. Frenza currently earns $100,000 in net income, and the new product line will yield $50,000 in additional income before any interest expense. Frenza has three options: (1) do not expand, (2) expand and issue $160,000 in debt that requires payments of 8% annual interest, or (3) expand and raise $160,000 from equity financing. For each option 1, 2, and 3, compute (a) net income and (b) return on equity (Net income ÷ Equity). Ignore any income tax effects.

Answer 1

The net income and return on equity for the first part for Frenzo will be $100000 and 25%.

How to calculate the net income?

The net income and return on equity for the first part will be:

Net income = $100000 - 0 = $100000.

Return on equity = (100000/400000) × 100 = 25%

The net income and return on equity for the second part will be:

Net income = $150000 - $12800 = $137200

Return on equity will be:

= (137200/400000) × 100

= 34.3%

The net income and return on equity for the third part will be:

Net income = ($150000 - 0) = $150000

Return on equity will be:

= (150000/560000) × 100

= 26.8%

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