You have the following information about two firms, Debt Free, Inc. and Debt Spree, Inc. Both firms have the same prospects for sales and EBIT, and both have the same level of assets, tax rate and borrowing rate. They differ in their use of debt financing.
Scenario Sales EBIT
Bad year 200 24
Normal year 275 30
Good year 380 49
Debt Free Debt Spree
Total assets 250 250
Tax rate 35 % 35 %
Debt 0 150
Equity 250 100
Borrowing rate 16 % 16
%
Calculate the interest expense for each firm:
Interest expense for Debt Free $
Interest expense for Debt Spree $
Calculate the following items for each firm for each scenario (bad year, normal year, good year): return on assets (ROA), net profit, and return on equity (ROE).