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 EBITDA of $38.9 million and operating income of $20.5 million. NoEquity, Inc., finances its $70 million in assets with $69 million in debt (on which it pays 10 percent interest annually) and $1 million in equity. NoDebt, Inc., finances its $70 million in assets with no debt and $70 million in equity. Both firms pay a tax rate of 21 percent on their taxable income. Calculate the net income and return on assets-funders' investments- for the two firms. (Enter your dollar answers in millions of dollars. Round "Net income" answers to 3 decimal places and "Return on assets" answers to 2 decimal places.) Answer is complete but not entirely correct. Net income NoEquity 10.744 NoDebt million $ 16.195 million Return on assets 15.35% 23.00 %
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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