Textbook Problem

Leverage

Cook Corporation issued financial statements at December 31, 2019, that include the following information:

Balance sheet at December 31,2019

Assets $8,000,000

Liabilities $1,200,000

Stockholders' equity (300,000 shares) $6,800,000

Income statement for 2019:

income from operations $1,200,000

Less: Interest expense (100,000)

Income before taxes $1,100,000

Less: Income taxes expense (0,30) (330,000)

Net income $ 770,000

The levels of assets, liabilities, stockholders' equity, and operating income have been stable in recent years; however, Cook Corporation is planning a 51,800,000 expansion program that will increase income from operations by $350,000 to $1,550,000, Cook is planning to sell 8.5% notes at par to finance the expansion.

Required:

3. Suppose income from operations will increase by only $150,000. Would this use of leverage be advantageous to Cook’s stockholders? Explain