Alexander Company has $1,000,000 in assets and $1,000,000 in stockholders’ equity, with 50,000 shares outstanding the entire year. It has a return on assets ratio of 10%. In the past year it had net income of $100,000. On January 1, 2010, it issued $500,000 in debt at 5% and immediately repurchased 25,000 shares for $500,000. Management expected that, had it not issued the debt, it would have again had net income of $100,000.

Instructions

(a) Determine the company’s net income and earnings per share for 2009 and 2010.

(Ignore taxes in your computations.)

(b) Compute the company’s return on common stockholders’ equity for 2009 and 2010.

(c) Compute the company’s debt to assets ratio for 2009 and 2010.

(d) Discuss the impact that the borrowing had on the company’s profitability and solvency.

Was it a good idea to borrow the money to buy the treasury stock?