Question

Check my work No-Toxic-Toys currently has $500,000 of equity and is planning an $200,000 expansion to meet increasing demand for its product. The company currently earns $175,000 in net income, and the expansion will yield $87,500 in additional income before any interest expense 071 points The company has three options: (1) do not expand, (2) expand and issue $200,000 in debt that requires payments of 9% annual Interest, or (3) expand and raise $200,000 from equity financing. For each option, compute(o) net income and (b) return on equity (Net Income Equity). Ignore any income tax effects. (Round "Return on equity to 1 decimal place.) References Equity Financing 202.500 Income before interest expense Interest expense Net income Don't Expand Debt Financing $175.000 $ 262.500l 18.000 $ 175.000 S 500 000 $ 500.000 $ 262500 $ 700.000 Equity Return on equity

Answer 1

Solution:

	1	2	3
	Don`t Expand	Debt Financing	Equity Financing
Income before interest expense (a)	$             175,000	$             262,500	$                   262,500
Interest expense (b)		$             (18,000)
Net Income (a-b)	$             175,000	$             244,500	$                   262,500
Equity	$             500,000	$             500,000	$                   700,000
Return on equity	35.0%	48.9%	37.5%

Notes:

1) If we expand income before interest expense will increase by $87,500 which leads to total income before interest expense of $262,500.

2) Under Debt Financing we have to pay interest on $200,000 @ 9% =$18,000