Windmere Corporation’s statement of financial position at December 31, 2020, appears as follows:

Cash ........................................................................    $    63,000

Other current assets .............................................    1,106,000

Capital assets (net) ................................................    7,140,000

Total ........................................................................  $8,309,000

Current liabilities ...................................................    $ 546,000

Long-term debt ......................................................   1,400,000

Preferred shares ...................................................       700,000

Share capital—common shares ..........................    2,100,000

Retained earnings .................................................    3,563,000

Total .......................................................................   $8,309,000

For the year just ended, Windmere reported net income of $540,000. During the year, the company declared preferred dividends of $50,000 and common dividends of $300,000.

Required

a. Calculate, using year-end amounts for assets and shareholders’ equity, the following ratios for Windmere:

i. return on assets, using net income in the calculation

ii. dividend payout ratio

iii. return on common shareholders’ equity

b. Assume that the company issued $1.4 million of common shares at the beginning of 2020 and paid off the long-term debt. By repaying the long-term debt and not incurring any interest expense, the company’s net income increased by $70,000.

i. What would the return on common shareholders’ equity be?

ii. Would common shareholders be better or worse off ?

iii. Does switching from debt to equity financing always have this effect on the return on common shareholders’ equity? Explain.

c. Assume that the long-term debt remains as shown on the statement of financial position and that the company issued an additional $700,000 of common shares at the beginning of 2020. The company used the proceeds to redeem and cancel the preferred shares.

i. What would the return on common shareholders’ equity be?

ii. Would shareholders be better or worse off ?

iii. Does switching from preferred equity financing to common equity financing always have this effect on the return on common shareholders’ equity? Explain.