Question

Exercise 10-1 Debt versus equity financing LO A1 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. 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 (a) net income and (b) return on equity (Net Income - Equity). Ignore any income tax effects. (Round "Return on equity" to 1 decimal place.)

Answer 1

Option 1 Option 2 Option 3 Add Current Net Income Additional Income EBIT Interest expense EBT/Net Income 175000 0 175000 0 175000 175000 87500 262500 18000 244500 175000 87500 262500 0 262500 Less Current Equity Newly issued Equity Total Equity Add 500000 0 500000 500000 0 500000 200000 700000 500000 Return on Equity (Net Income/Equity) 0.35 35.0% 0.489 48.9% 0.375 37.5%