Question

You 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 $32.5 million. NoEquity, Inc., finances its $65 million in assets with $64 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc., finances its $65 million in assets with no debt and $65 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. Return on assets = net income / total assets Accounting equation: total assets = total liabilities debt + total equity

Answer 1

Answer:

A. NoEquity $18.27million

NoDebt $22.75million

B. NoEquity 28.11%

NoDebt 35%

Explanation:

A. Calculation to determine the net income

NoEquity Inc., NoDebt Inc.,

Operating income $32.5 million $32.5 million

Less: Interest $6.4 million $0

($64m × 0.1)

Taxable income $ 26.10million $32.5 million

Less: Taxes (30%) ($7.83million) ($9.75million)

NET INCOME $18.27million $22.75million

Therefore The Net income for the two firms are :

NoEquity $18.27million

NoDebt $22.75million

B. Calculation to determine the Return on assets

NoEquity

Return on assets =$18.27million/$65 million

Return on assets =0.2811*100

Return on assets =28.11%

NoDebt

Return on assets = $22.75million/$65 million

Return on assets =0.35*100

Return on assets =35%

Therefore The return on assets for the two firm are:

NoEquity 28.11%

NoDebt 35%