Question:
Assume you are about to start a new company. Let’s call it Super Health, Inc. The business requires $200,000 in assets to get into operation, and there are only two financing alternatives available to you are 1) all equity (all common stock) and 2) 50 percent equity and 50 percent debt.
Following is the business’s projected financial statements under the two financing alternatives. The business will require $100,000 in current assets and $100,000 in fixed assets to begin operations.
Since the asset requirement depends upon on the nature and size of the business rather than on how the business will be financed, the assets side of the balance sheet is unaffected by the financing schemes. However, the capital, or claims side, is influenced by the type of financing.
Under the all equity alternative, you will put up the entire $200,000 needed to purchase the assets. If 50 percent debt financing is used, you will contribute only $100,000 of your own funds and the remaining $100,000 will be obtained from creditors, say, a bank loan at 10 percent interest rate. Your task is to complete all of the ? spaces and make a recommendation regarding which financing alternative to select and why?
Super Health, Inc: projected Financial Statements under Two Financing Alternatives.
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Stock
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Stock/Debt
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Balance Sheet
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Current Assets
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$100,000
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$100,000
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Fixed Assets
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$100,000
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$100,000
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Total Assets
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$200,000
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$200,000
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Bank Loan @ 10% cost
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0
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?
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Common Stock
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$200,000
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?
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Income Statement
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Revenues
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$150,000
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$150,000
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Operating Costs
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$100,000
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$100,000
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Operating Income
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$ 50,000
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$ 50,000
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Interest Expense
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$0
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?
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Taxable Income (40% Rate)
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?
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?
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Net Income
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?
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?
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Return on Investment
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?
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?
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