You are considering a stock investment in one of two firms (AllDebt, Inc., and A

Question

You are considering a stock investment in one of two firms (AllDebt, Inc., and AllEquity, Inc.), both of which operate in the same industry and have identical operating income of $11.00 million. AllDebt, Inc., finances its $35 million in assets with $34 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. AllEquity, Inc., finances its $35 million in assets with no debt and $35 million in equity. Both firms pay a tax rate of 30 percent on their taxable income.

Calculate the income available to pay the asset funders (the debt holders and stockholders) and resulting return on asset-funders' investment for the two firms. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.)

Calculate the income available to pay the asset funders (the debt holders and stockholders) and resulting return on asset-funders' investment for the two firms. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.)

Explanation / Answer

Answer:

Particulars All Debt All equity Operating income 11 11 Less: interest 3.4 0 Taxable income 7.6 11 Less:taxes @30% 2.28 3.3 Net income 5.32 7.7 Income available for asset funders( operating income-taxes) 8.72 7.7 Return on asset funder's investment 24.91% 22.00% 8.72/35=24.91% 7.7/35=22%

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