Question: Cabo Company has $1,000,000 in assets and $1,000,000 in stockholders' equity, with 40,000 shares outstanding the entire year. It has a return on assets of 10%. During 2016, it had net income of $100,000. On January 1, 2017, it issued $400,000 in debt at 4% and immediately repurchased 20,000 shares for $400,000. Management expected that, had it not issued the debt, it would have had net income of $100,000 in 2017.
Instructions: (a) Determine the company's net income and earnings per share for 2016 and 2017. (Ignore taxes in your computations.)
(b) Compute the company's return on common stockholders' equity for 2016 and 2017.
(c) Compute the company's debt to assets ratio for 2016 and 2017.
(d) Discuss the impact that the borrowing had on the company's profitability and solvency. Was it a good idea to borrow the money to buy the treasury stock?