Question

You are considering a stock investment in one of two firms(No Equity Inc. and NoDebt inc),both of which operate in the same industry and have identical operating income of 9.5 million. No equity 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. NoDebt 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 net income and return on assets for the two firms.

Answer 1

No Equity Inc.:

Value of Asset = $30,000,000
Value of Debt = $29,000,000
Interest Rate = 10%

Interest Expense = Value of Debt * Interest Rate
Interest Expense = $29,000,000 * 10%
Interest Expense = $2,900,000

No Debt Inc.:

Value of Asset = $30,000,000
Value of Equity = $30,000,000

Interest Expense = $0