Chapter 02 - Reviewing Financial Statements
42. Debt versus Equity Financing 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 $3 million. AllDebt, Inc. finances its $6 million in assets with $5 million in debt (on which it pays 5 percent interest annually) and $1 million in equity. AllEquity, Inc. finances its $6 million in assets with no debt and $6 million in equity. Both firms pay a tax rate of 40 percent on their taxable income. What are the asset funders' (the debt holders and stockholders') resulting return on assets for the two firms? A. 27.5%, and 30%, respectively B. 31.67%, and 30%, respectively C. 33%, and 30%, respectively D. 50%, and 50%, respectively
Return on assets funders' investment $1.9m/$6m = 31.67% $1.8m/$6m = 30.00% AACSB: Analytical Blooms: Apply Difficulty: 2 Intermediate Learning Objective: 02-01 Recall the major financial statements that firms must prepare and provide. Topic: Understanding Financial Statements