Suppose that Banana Computers has $1,000 in revenue this year, along with COGS of $400 and SG&A of $100. The required rate of return on its equity is 14%, and the risk-free rate is 5%. Assume that the COGS only include the marginal costs of selling a computer. Banana is considering adding $700 worth of debt with a coupon rate of 5% and an YTM of 7.9% to its capital structure. What is the net income of Banana without and with the debt?
A) $500 and $484.2
B) $484.2 and $500
C) $500 and $465
D) $490 and $500

Question

Quizplus · Accepted Answer

Without debt, net income is $500 ($1,000 revenue - $400 COGS - $100 SG&A). With debt, interest expense is $700 * 5% = $35, so net income is $500 - $35 = $465.

Suppose That Banana Computers Has $1,000 in Revenue This Year