Question

Wisner Corporation's financial statements for 2019 showed the following:

Income Statement

Revenues: 600,000

Selling and Administrative Expenses: (200,000)

Interest Expense: (7,200)

Pretax Income: 392,800

Income Tax (35%): (137,480)

Net Income: 255,320

Balance Sheet

Assets: 500,000

Liabilities (average interest rate 5%): 120,000

Contributed Capital: 200,000

Retained Earnings: 180,000

Total Liabilities and Stockholders' Equity: 500,000

This company has debt of $120,000 and contributed capital of $200,000. A consultant recommended that a better capital structure would be $220,000 debt and contributed capital of $100,000. Assume the company pays no dividends, the interest on the debt would be paid in cash annually at 6%, and income taxes are paid in cash annually.

1. Prepare the adjusted income statement for 2018 as if Wisner was under the alternative capital structure.

2. Complete the following table for 2018: For ratios use year end balances.

Item	Results with the current capital structure	Results if the firm had the recommended capital structure (more debt and less equity)
Total Debt
Total Assets
Contributed Capital
Retained Earnings
Total Stockholders' Equity
Return on Assets
Return on Equity

3. What do you think of the consultant's recommendation?

Answer 1

Income Statement

Particular	Amount
Revenue	600000
Selling Expenses	(200000)
Interest Expenses	(13200)
Pretax Income	386800
Income Tax (35%)	(135380)
Net Income	251420

   Table

Item	Results with the current capital structure	Results if the firm had the recommended capital structure
Total debt	$120000	$220000
Total Assets	$500000	$500000
Contributed Capital	$200000	$100000
Retained Earnings	$180000	$180000
Total Stockholder's Equity	$380000	$280000
Return on Assets*	255320/500000*100=51.06%	251420/500000*100=50.28%
Return on Equity**	255320/380000*100=67.19%	251420/280000*100=89.79%

*Return on Assets= Net income/ Total Assets*100

** Return on equity= Net income/Total Stockholder's Equity*100

Wisner opts for second capital structure its return on assets decreases by a negligible percentage but returns on equity increases by a significant percentage. Therefore Wisner should opt for the second capital structure