Item Case 1 Case 2 Equity (all cash) $1,000,000 $100,000 Debt Loan @ 12% $0 $900,000 Sale $1,100,000 $1,100,000 Less Cost $1,000,000 $1,000,000 Less Interest Expense 0 $27,000 (0.12x900,000)/360 x 90 days) Net Income $100,000 $73,000 Return on Equity 10% 73% (Net Income/Equity)
Note: Taxes ignored in calculations.
1. Which case would you find more beneficial for the short and the long term as a shareholder?
2. What do you see as the risk to the lender?
3. What are some ways in which the lender can protect themselves?
4. Would you say that the lender and the shareholders are in alignment or in conflict?