Question

you are considering a stock investment in one of two firms (NoEquity, Inc. and NoDebt, Inc.), both of which operate in the same industry and have identical operating income of $12.0 million. NoEquity, Inc. finances its $20 million in assets with $19 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc. finances its $20 million in assets with no debt and $20 million in equity. Both firms pay a tax rate of 30 percent on their taxable income. Calculate the net income and return on assets for the two firms. (Enter your dollar answers in millions of dollars. Round all answers to 2 decimal places.)

Answer 1

Answer / Explanation:

Fir let us define some terms:

Operating income: In accounting, this refers the the operation profit realized from a business transaction

Taxable income: This is also referred to as the adjusted gross income. That total gross income excluding any from of statutory deductions.

Considering the statement that states that they run identical operating income, that gives us :

Operating income = $ 12.0 million and $ 12.0 million (identical operating income)

Referring to the statement in the question again,

Less: Interest is = ($ 19 million × 0.1) 1.90 million 0 m

Therefore, to measure the taxable income,

we have taxable income = $ 20.60 million and $ 25.50 million

Less: Taxes (30%) = 6.18 ,million and 7.65 million

Net income $ 14.42 million and $ 17.85 m million

For No Equity , we have return on asset to be:

Return on assets = $14.42 million / $20 million = 7.21%

For No Debt, we have:

Return on assets = $17.85 million /$20 million= 89.25%