Question

SHOW FORMULA & CALCULATIONS PLEASE!

Analyzing the Use of Debt

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

Solution:	Comparative Analysis
	Particulars	Actual Result for 2017	Results with an $80,000 increase in debt and an $ 80,000 decrease in equity
	Total Debt (1)	20,000	1,00,000
	Total Assets (2)	3,00,000	3,00,000
	Total Shareholders' equity 3= (2-1)	2,80,000	2,00,000
	Interest Expenses (W.No.: 1 and 2)	2,000	10,000
	Net Earnings (W.No.: 1)	70,000	64,400
	Return on Total Assets	23.33%	21.47%
	Earnings available to sharesholders:
	1. Amount	70,000	64,400
	2. Per Share	3.50	5.37
	3. Return on Shareholders Equity	25.00%	32.20%

Consultant's Recommendation
As per above compartive analysis Return on Shareholders' Equity is more in proposed debt and capital figures then actual result for 2017. Hence we can conclude that, we can go with his/her recommendation.

Note:	Formulas
	Total Debt	Total debt means liabilities.
	Total Assets	Total debt means sum of assets in the Statement of Financial Position.
	Total Shareholders' equity	Total shareholders'r equity the difference between total assets and total liabilities.
	Interest Expenses	Liabilities*Average Rate of Interest
	Net Earnings	1. Pretax Earnings= Total Income- Total Expenes 2. Net Earnings= Pretax Earnings- Income Tax
	Return on Total Assets	Net Earnings/Total Assets*100
	Earnings available to sharesholders:
	1. Amount	Net Earnings-Dividend (If any)
	2. Per Share	Total Amount available to Shareholders/Total No. of Shares
	3. Return on Shareholders Equity	Net Earnings/Total Shareholders' Equity*100

W.No.: 1	Statement of Earnings	Actual ($)	Proposed ($)
	Revenues	3,00,000	3,00,000
	Expenses	-1,98,000	-1,98,000
	Interest Expenses (W.No.: 2)	-2,000	-10,000
	Pretax Earnings	1,00,000	92,000
	Income Tax (30%)	-30,000	-27,600
	Net Earnings	70,000	64,400

W.N.: 2	Propose Debt	1,00,000
	Interest Expenses on Proposed Debt (10%)	10,000