Question

Chapter 10 Exercise i Saved Help Save & Exit Submit Check my work No-Toxic-Toys currently has $200,000 of equity and is planning an $80,000 expansion to meet increasing demand for its product. The company currently earns $70,000 in net income, and the expansion will yield $35,000 in additional income before any interest expense. 0.71 points The company has three options: (1) do not expand, (2) expand and issue $80,000 in debt that requires payments of 11% annual interest, or (3) expand and raise $80,000 from equity financing. For each option, compute (a) net income and (b) return on equity (Net Income : Equity). Ignore any income tax effects. (Round "Return on equity" to 1 decimal place.) eBook Print 1 2 Don't Expand Debt Financing 3 Equity Financing References Income before interest expense Interest expense Net income Equity Return on equity % %

Answer 1

1) Do not expand:

Equity shares $200,000

Net Income $70,000

Income before interest $70,000

Less :Interest Expense 0

Net Income $ 70,000

Equity $ 200,000

ROE= Net Income/Equity= (70,000/200,000)*100

= 35%

2. Exapnd and issue 80,000 in debt

INterest rate 11%

Interest expense= 80,000*11%= 8,800

Income before INterest =70,000+35,000= 105,000

Less: Interest Expense= (8,800)

Net Income= 105000-8800= $96,200

Equity= 200,000

ROE= (96,200/200,000)*100= 48.1%

3. Expand and Raise $80,000 from equity

Equity= 200,000

addition= 80,000

Total= $280,000

net income before interest= 70,000+35,000= 105,000

less: INterest expense= 0

Net Income= 105,000

Equity= 280,000

ROE= (105,000/280,000)*100

=37.5%