The Utopia Paper Company requires $5 million of financing to upgrade its production facilities. It has a choice to finance the upgrade with a 6% non-current loan or to issue additional shares. The company currently has total assets of $12 million, total liabilities of $8 million, shareholders' equity of $4 million, and profit of $2 million.
It projects that profit will be $315,000 higher if debt is issued and $525,000 higher if shares are issued. Assume the project is invested in at the beginning of the year.
Instructions
(a) Calculate the debt to total assets and return on equity ratios under each financing alternative.
(b) Which financing alternative would you recommend for Utopia Paper? Why?