Faber Products has $35 million of sales and $9.75 million of net income. Its total assets are $150 million. Assume the company’s total assets equal total invested capital, and its capital structure consists of 40% debt and 60% common equity. The firm’s interest rate is 4%, and its tax rate is 21%. What would happen if this firm used less leverage (debt)?

If the firm uses less leverage, its ROE will decrease since the cost of equity is much higher than the cost of debt. If all debt is eliminated, then ROE will decrease to 7.764% from 10.83%.

Explanation:

net income = $9.75 million

capital structure:

interest rate = 4% and tax rate = 21%

current return on equity (ROE) = $9.75 / $90 = 10.83%

current return of assets (ROA) = $9.75 / $150 = 6.5%

cost of debt = 4% x (1 - 21%) = 3.16%

if the company issues more equity to lower debt to 0, then:

net income = $9.75 + [$60 million x 4% x (1 - 21%)] = $9.75 + $1.896 = $11.646 million

return on equity (ROE) = $11.646 / $150 = 7.764%

return of assets (ROA) = $11.646 / $150 = 7.764%

the correct answer is economics is a game without winners or losers.

unlike sports or games economic is a game without losers or winner rather it is a game where everyone wins. parties of business doing businesses exchange money with each other and hence exchange is done on the basis of goods. one party takes the goods and other sales it so there is winner on both sides. each party values more highly the good it gets than the good it gives up. both sides exchange only because both intend to increase their value. so there is no concept of lose or win.