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Chrome File Edit View History Bookmarks People Window Help :40 PM O E (1) Studert Center Assignments-2017 Fall Term × 5 You > C Secure https://bbhosted.cuny.edu/webapps/blackboard/content/listContent.jsp?course_id=-1447951-1&content;_id_-30459492-1&mode-...; AppsSuggested Sites Imported From IE Google Earth Student Center CChegg Study | Guid... Middle East News-f Homeo New Tab Lehman College An organization is planning to invest $500,000 in assets to begin operations. It pays taxes at a 30% rate. The organization plans to finance 10% of debt to acquire its assets, with an interest rate of 10%. Revenues are an estimated $250,000. Operating costs are also anticipated to be $120,000. Construct a P&L; statement using the above data to determine the impact the new capital structure would have on profit, dollar return and equity. Indicate the optimal choice for investors based on the ROE. All Equity Total? 796 Debt Equity ? Financed Total $? ALL EQUITY ?%DEBT Line 1 Line 2 Line 3 Line 4 Line 5 Operating Costs Operating Income Interest Expense Taxable Income 13

Explanation / Answer

Ans:

In this case there are two alternatives

Alternative - 1 All equity = $5,00,000

Alternative - 2 (10% Debt + 90% equity)

10% Debt = $50,000

90% equity = $4,50,000

Profit and Loss statement

ROE = Net Income/Shareholders equity

Alternative -1 = $91,000 / $500,000

= 0.182 or 18.2%

Alternative - 2 = $87500 / $4,50,000

= 0.194 or 19.4%

Based on ROE, the optimal choice for investors is Alternative-2 with capital structure of debt and equity. since the ROE is higher.

Particulars All Equity 10% Debt and 90% equity Revenue $2,50,000 $2,50,000 Less: Operating cost $120,000 $1,20,000 Operating income $1,30,000 $1,30,000 Less: Interest expenses($50,000 * 10%) - $5000 Taxable Income $1,30,000 $1,25,000 Less:Tax@30% $39,000 $37500 Net Income $91,000 $87,500

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