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.

Question

Business

Nick Zamora

15 May, 21:05

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.

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Mcintosh · Answer 1

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%