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 $10.00 million. AllDebt, Inc., finances its $25 million in assets with $24 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. AllEquity, Inc., finances its $25 million in assets with no debt and $25 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.)

Explanation / Answer

Particulars All Debt Inc. All Eqquity Inc. Operating income $10.00 $10.00 Less: Interest on debt $2.40 $0.00 Earning before tax $7.60 $10.00 Less: Tax @ 30% $2.28 $3.00 Earnings after tax $5.32 $7.00 Earnings available for shareholders $5.32 $7.00 Return on asset funders Debt holders $0.10 Shareholders 532.00% 28.00%

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