Top management of Cabo company is considering two alternative capital structures for 2025 . The first (the "no debt" structure) would be to have \(\$ 1,000,000\) in assets and \(\$ 1,000,000\) in stockholders' equity, with 40,000 shares outstanding the entire year. This is the structure the company had on December 31, 2024. Alternatively, (the "with debt" structure) on January 1, 2025, the company could issue \(\$ 400,000\) in debt at \(4 \%\) interest and immediately use the proceeds to repurchase 20,000 shares of stock for \(\$ 400,000\). The expected amount of net income (ignoring taxes), prior to any interest costs, is \(\$ 100,000\) for 2025 .

Assume the company pays dividends on common stock equal to its net income each year. Also, assume the accrued interest on the debt was paid at December 31, 2025, and the company has no other debt outstanding at year-end. Also, assume the company has \(\$ 1,000,000\) in assets at both the beginning and the end of 2025 .

Instructions

a. Compute the company's net income and earnings per share under both structures. (Ignore income taxes in your computations.)

b. Compute the company's return on common stockholders' equity and return on assets under both structures.

c. Compute the company's debt to assets ratio under both structures.

d. Discus the impact that the borrowing had on the company's profitably and solvency. Was it a good idea to borrow the money to buy the treasury stock?