Two companies, Shipton Ltd. and Falco Corporation, began operations with identical balance sheets. A year later, both required additional manufacturing capacity at a cost of $100,000. Shipton obtained a 5-year, $100,000 loan at a 7% interest rate from its bank. Falco, on the other hand, decided to lease the required $100,000 capacity for 5 years, and a 7% return was built into the lease. The balance sheet for each company, before the asset increases, follows:

a. Show the balance sheets for both firms after the asset increases and calculate each firm's new debt ratio. (Assume that the lease is not capitalized.) 

b. Show how Falco's balance sheet would look immediately after the financing if it capitalized the lease.

c. Would the rate of return (1) on assets and (2) on equity be affected by the choice of financing? How?

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Debt $100,000 Equity Total claims 300,000 Total assets $400,000 $400,000