Question

ou are considering a stock investment in one of two firms (NoEquity, Inc. and NoDebt, Inc.), both of which operate in the same industry and have identical operating income of $22.5 million. NoEquity, Inc. finances its $80 million in assets with $79 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc. finances its $80 million in assets with no debt and $80 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. Calculate the net income and return on assets for the two firms. (Enter your dollar answers in millions of dollars.

Answer 1

Answer:

Explanation:

a) No Equity Inc:

Net Income = (EBIT – Interest) * (1-T) = (22.5– 79 * 0.10) * (1-0.30)

= 14.6 * 0.7  = 10.22

Return on assets = Net Income / Total Assets = 10.22 / 80 = 12.775%

b) No Debt Inc:

Net Income = (EBIT – Interest) * (1-T) = (22.5 – 0) * (1-0.30)

= 22.5 * 0.7   = 6.75

Return on assets = Net Income / Total Assets = 6.75 / 40 = 16.875%