exercise details: FIT corporation’s return on net operating assets (RNOA) is 10% and its tax rate is 40%. Its net operating assets ($4 million) are financed entirely by common shareholders’ equity. Management is considering its options to finance an expansion costing $2 million. It expects return on net operating assets to remain unchanged. There are two alternatives to finance the expansion:

1.       Issue $1 million bonds with 12% coupon, and $1 million common stock

2.       Issue $2 million bonds with 12% coupon

Questions:

1.       Determine net operating income after tax (NOPAT) and net income for each alternative

2.       Computer return on common shareholders’ equity for each alternative (use ending equity)

3.       Calculate the assets-to-equity ratio for each alternative

4.       Compute return on net operating assets and explain how the level of leverage interacts with it in helping determine which alternative management should pursue