Analyzing the Use of Debt
Arbor Corporation's financial statements for 2011 showed the following
Income Statement | ||
Revenues | $300,000 | |
Expenses | (196,000) | |
Interest expense | (4,000) | |
Pretax income | 100,000 | |
Income tax (40%) | (40.000) | |
Net income | $ 60,000 | |
Balance Sheet | ||
Assets | $360,000 | |
Liabilities (average interest rate, 10%) | $ 40,000 | |
Common stock, par $10 | 230.000 | |
Retained earnings | 90.000 | |
q | $360,000 | |
Notice in these data that the company had a debt of only $40,000 compared with common stock outstanding of $230,000. A consultant recommended the following: debt, $90.000 (at 10 percent) and common stock outstanding of $180,000 (18,000 shares). That is. the company should finance the business with more debt and less owner contribution.
Required (round to nearest percent):
1. You have been asked to develop a comparison between (a) the actual results and (b) the results had the consultant's recommendation been followed. To do this, you develop the following schedule:
Item | Actual Results for 2011 | Results with an Increase in Debt and Reduction in Equity |
a.Total debt |
| |
b.Total assets | ||
c.Total stockholders' equity | ||
d.Interest expense (total at 10 percent) | ||
e.Net income | ||
f. Return on total assets | ||
g. Earnings available to stockholders: | ||
(1) Amount | ||
(2) Per share | ||
(3) Return on stockholders' equity | ||
2. Based on the completed schedule in requirement (1). provide a comparative analysis and interpretation of the actual results and the consultant's recommendation.
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