Textbook Problem

Evaluating Leverage

Gearing Manufacturing Inc. is planning a $1,000,000 expansion of its production facilities. The expansion could be financed by the sale of $1,250,000 in 8% notes or by the sale of $1,250,000 in common stock, which would raise the number of shares outstanding from 50,000 to 75,000. Gearing pays income taxes at a rate of 30%.

Required:

4. As an investor, how would you use accounting information to evaluate the risk of excessive use of leverage? What additional information would be useful? Explain.