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 $10.5 million. NoEquity, Inc. finances its $35 million in assets with $34 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc. finances its $35 million in assets with no debt and $35 million in equity. Both firms pay a tax rate of 30 percent on their taxable income.​

Answer 1

I am assuming that you have to compute income available to pay asset funders (since no question has been asked above):

		NoEquity	NoDebt
Operating income (in $ millions)		10.50	10.50
less: interest	34*10%	3.40	0.00
Taxable income		7.10	10.50
less: tax @30%		2.13	3.15
Net income		4.97	7.35
Income available for asset funders		8.37	7.35

Return on assets for noequity = 8.37/35 = 23.91%

Return on assets for nodebt = 7.35/35 = 21.00%

Calculations:

Income available for asset funders = Operating income - taxes. Thus for Noequity it is = 10.5-2.13 = $8.37 million and for nodebt it is 10.5-3.15 = $7.35 million.