Two textile companies, Grimm Manufacturing and Wright Mills, began operations with identical balance sheets. A year later, both required additional manufacturing capacity at a cost of $200,000. Grimm obtained a five year, $200,000 loan at an 8 percent interest rate from its bank. Wright, on the other hand, decided to lease the required $200,000 capacity from American Leasing for five years; an 8 percent return was built into the lease. The balance sheet for each company, before the asset increases, is as follows:

a. Show the balance sheet of each firm after the asset increase, and calculate each firm€™s new debt ratio. (Assume Wright€™s lease is kept off the balance sheet.)
b. Show how Wright€™s balance sheet would have looked immediately after the financing if it had capitalized the lease.
c. Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? How?

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Debt $200,000 Equity Total liabilities and Total assets $400.000 $400.000 equity