Question

Analyzing the Use of Debt (Show Calculations)

Cricket Corporation’s financial statements for 2017 showed the following:

Statement of Earnings
Revenues	$300,000
Expenses	(198,000)
Interest expense	(2,000)
Pretax earnings	100,000
Income tax (30%)	(30,000)
Net earnings	$  70,000
Statement of Financial Position
Assets	$300,000
Liabilities (average interest rate, 10%)	20,000
Share capital	200,000
Retained earnings	80,000
	$300,000

Notice that the company had a debt of only $20,000 compared with share capital of $200,000. A consultant recommended the following: debt, $100,000 (at 10 percent) instead of $20,000, and share capital of $120,000 (12,000 shares) instead of $200,000 (20,000 shares). That is, the company should finance the business with more debt and less owner contribution.

Required (round to the nearest percent):

1. You have been asked to develop a comparison between (a) the actual results and (b) the results based on the consultant’s recommendation. To do this, you decided to develop the following schedule:

   Item	Actual Results for 2017	Results with an $80,000 Increase in Debt and an $80,000 Decrease in Equity
   Total debt
   Total assets
   Total shareholders’ equity
   Interest expense
   Net earnings
   Return on total assets
   Earnings available to shareholders:
   (1) Amount
   (2) Per share
   (3) Return on shareholders’ equity

2. Based on the completed schedule in (1), provide a comparative analysis and interpretation of the actual results and the consultant’s recommendation.

Answer 1

1.You have been asked to develop a comparison between (a) the actual results and (b) the results based on the consultant’s recommendation. To do this, you decided to develop

Item	Actual Results for 2017	Results with a $ 80,000 increase in Debt and $ 80,000 decrease in Equity
a.	Total Debt	$ 20,000	$ 100,000
b.	Total Assets	300,000	294,400
c.	Total Shareholders' Equity	280,000	194,400
d.	Interest Expense	2,000	10,000
e.	Net Earnings	70,000	64,400
f.	Return on Total Assets	23.33 %	21.88 %
g.	Earnings available to shareholders
1.	Amount	$ 70,000	$ 64,400
2.	Per Share	$ 3.50	$ 5.37
3.	Return on Shareholders' Equity	25 %	33.13 %

2.Based on the completed schedule in (1), provide a comparative analysis and interpretation of the actual results and the consultant’s recommendation

Explantion:

As a conclusion of the consultant's advice
, there is a reduction in whole assets, bcoz of the greater net profit costs. But incomes per share rise from $ 3.50 per share to $ 5.37 per share. This would manage to a rise in the exchange value of the stock, and add to stockholder money. Profit on whole assets falls down, hence the actual raise in ROE, increased by an increased investment multiplier.

Revised Statement of Earnings
Revenues	$ 300,000
Expenses	(198,000)
Interest Expense	(10,000)
Pretax Earnings	92,000
Income Tax ( 30 % )	(27,600)
Net Earnings	$ 64,400

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