Question

You are considering a stock investment in one of two firms (NoEquity, Inc., and NoDebt, Inc.), both of which operate in the same industry and have identical operating income of $15.5 million. NoEquity, Inc., finances its $70 million in assets with $69 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc., finances its $70 million in assets with no debt and $70 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. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.)

	NoEquity	NoDebt
Net income	$  m	$  m
Return on assets	%	%

Answer 1

Particulars	No equity Inc	No Debt Inc.
Operating Income	15,500,000	15,500,000
Less: Interest	6,900,000	-
Earning before tax	8,600,000	15,500,000
Less: Tax @30%	2,580,000	4,650,000
Net Income	6,020,000	10,850,000
Net Income	6.02 million	10.85 million
Total assets	70,000,000	70,000,000
Return on assets	8.60%	15.50%