Benefits of Financial Leverage. A majority shareholder of Okemos Products has forced the company to hold debt to a minimum. Net income each year has been approximately \(\$ 7,200,000\). A summary balance sheet for a typical year is:

A younger member of the board, Carla Freed, is irritated with such a cautious policy. "We would be better off to liquidate and invest in government securities," she protests. She states that with new product lines and an agyressive sales stance, net income could easily grow to \(\$ 15,000,000\) a year. She admits that \(\$ 30,000,000\) in additional assets would be needed and states, "The additional assets should be financed by long-term notes." Other balance sheet relationships would remain unchanged.
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1. Compute the typical rate of return on assets and shareholders' equity 2. Compute the revised rate of return on assets and shareholders' equity by following the younger member's proposal.
3. Comment on the two strategies. What will be the primary arguments on both sides at the board meeting? Which do you favor?

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Current assets Plant and equipment (net). Total assets Current liabilities Shareholders' equity Total liabilities and shareholders' equity. $ 80,000,000 40,000,000 $120,000,000 $ 30,000,000 90,000,000 $120,000,000