Tracey White, owner of the buzz Coffee Shop chain, has decided to expand her

| March 29, 2017

Question
Tracey White, owner of the buzz Coffee Shop chain, has decided to expand her operations. Her 2006 financial statements follow. Tracey can buy two additional coffeehouses with either a 10 percent (annual interest) loan or the issuance of new common stock. She also expects these new shops to generate an additional $1 million in sales. Assuming a 40 percent tax rate and no other changes, should Tracey buy the two coffeehouses? Why or why not? Which financing option results in the better ROE?

Buzz Coffee Shops, Inc. 2006 Financial Statements

Balance Sheet

Current assets $250,000

Fixed assets 750,000

Total assets $1,000,000

Current liabilities $300,000

Long-term debt 0

Total liabilities $300,000

Common equity $700,000

Total liabilities and $1,000,000

Stockholder’s equity

Income Statement

Sales $500,000

-Costs and expenses@40% 200,000

Earnings before interest and taxes (EBIT) $300,000

– Interest expense 0

Net profit before taxes $300,000

– Taxes @ 40% 120,000

Net income $180,000

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