Matthew Clough is the founder of Stone 1 Cloth. Assume that his company currently has $250,000 in equity, and he is considering a $100,000 expansion to meet increased demand. The $100,000 expansion would yield $16,000 in additional annual income before interest expense. Assume that the business currently earns $40,000 annual income before interest expense of $10,000, yielding a return on equity of 12% ($30,000y$250,000). To fund the expansion, he is considering the issuance of a 10-year, $100,000 note with annual interest payments (the principal due at the end of 10 years).
1. Using return on equity as the decision criterion, show computations to support or reject the expansion if interest on the $100,000 note is
(a) 10%,
(b) 15%,
(c) 16%,
(d) 17%,
(e) 20%.
2. What general rule do the results in part 1 illustrate?

  • CreatedApril 23, 2015
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