You Are Considering a Stock Investment in One of Two

question 116

Multiple Choice

You are considering a stock investment in one of two firms (AllDebt, Inc. and AllEquity, Inc.) , both of which operate in the same industry and have identical operating income of $3 million. AllDebt, Inc. finances its $6 million in assets with $5 million in debt (on which it pays 5 percent interest annually) and $1 million in equity. AllEquity, Inc. finances its $6 million in assets with no debt and $6 million in equity. Both firms pay a tax rate of 40 percent on their taxable income. What are the asset funders' (the debt holders and stockholders) resulting return on assets for the two firms?

• A) 27.5%, and 30%, respectively
• B) 31.67%, and 30%, respectively
• C) 33%, and 30%, respectively
• D) 50%, and 50%, respectively

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Definitions:

Examples

Specific instances used to illustrate a point, concept, or method.

Use

The act of employing something for a particular purpose or in a specific manner.

Chattel Mortgage

A loan arrangement where personal movable property is used as security for a debt, but the borrower retains possession of the property.

Debtor

An individual, company, or other entity that owes money or other forms of financial obligation to a creditor.