Question

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 $9.50 million. AllDebt, Inc., finances its $30 million in assets with $29 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. AllEquity, Inc., finances its $30 million in assets with no debt and $30 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. Calculate the income available to pay the asset funders (the debt holders and stockholders) and resulting return on asset-funders' investment for the two firms. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.) AllDebt AllEquity Income available for asset funders $ m $ m Return on asset-funders' investment % %

Answer 1

	No Equity	No Debt
Net income	4.62 Million	6.65 Million
Return on assets	15.40%	22.17%

Workings

	No Equity	No Debt
Operating income	$9.50 Million	$9.50 Million
Less : Interest on Debt [ $29 Million x 10% ]	2.90 Million	-
Income Before Tax	$6.60 Million	$9.50 Million
Less : Tax at 30%	1.98 Million	2.85 Million
Net Income available to pay the asset funders	4.62 Million	6.65 Million

Return on assets

No Equity = [ $4.62 Million / $30 Million ] x 100 = 15.40%

No Debt = [ $6.65 Million / $30 Million ] x 100 = 22.17%