Part A: Please complete the following table with the type of security (Trading,
ID: 2490738 • Letter: P
Question
Part A: Please complete the following table with the type of security (Trading, Available for Sale, or Held to Maturity), AND the type of unrealized gains/losses (Temporary or Permanent).
TYPE OF GAIN/LOSS
TYPE OF INVESTMENT
TYPE OF GAIN / LOSS
Unrealized Gain - Income
Unrealized Gain - Equity
Unrealized Loss - Equity
Unrealized Loss - Income
Part B: The following are key statistics for two similar companies.
ATTRIBUTE
DEGAREVEL COMPANY
YTIUQE COMPANY
Return on Assets
20%
20%
Equity
$100,000
$300,000
10% Bonds issued at face value
200,000
0
The two companies have no other liabilities or equity, and assume no corporate taxes. Hint: A = L + E
Required: Compute the return on contributed equity for each of the two companies and comment on the effectiveness of financial leverage. DESCRIPTIVELY SHOW YOUR WORKINGS
TYPE OF GAIN/LOSS
TYPE OF INVESTMENT
TYPE OF GAIN / LOSS
Unrealized Gain - Income
Unrealized Gain - Equity
Unrealized Loss - Equity
Unrealized Loss - Income
Explanation / Answer
2) ROA=Net Income/Total assets
In this case Assets= Liabilities+ Equity
Degarevel Company= .2=Net Income/100000+200000
.2*300000=Net Income= $60000
Net Income is this case we will assume that it is EBIT that the effcet of financila leverage can be shown as tax and others are nil.
So, cost of debt is 10% of 200000= $20000
Income for equityholder=60000-20000=$40000 i.e 40%
Ytiuqe Company= .2=Net Income/300000=$60000 this whole belongs to equityholders
So, 60000/300000*100=20%
So due to financial leverge Degarevel Company equityholder were able to earn 40% on their shares while Ytiuqe comany shareholder were able to earn 20%
Financial leverage means acquiring assets with the funds provided by creditors and preferred stockholders for the benefit of common stockholders. It means that the assets acquired with the funds provided by creditors generate a rate of return that is higher than the rate of interest payable to the providers of funds. When wepay interest we also get tax deduction which decrease the cost of fund borrowed i.e the rate of interest
Type of Gain/ Loss Type of Investment Type of Gain/Loss Unrealized Gain-Income Trading Temporary Available For sale Permanent Held to maturity Not applicable Unrealized Gain-Equity Trading Permanent Available For sale Permanent Held to maturity Not applicable Unrealized Loss-Income Trading Temporary Available For sale Permanent Held to maturity Not applicable Unrealized Loss-Equity Trading Permanent Available For sale Permanent Held to maturity Not applicable