CAPITAL STRUCTURE AND THE COST OF CAPITAL External ...

Debt financing and Toy Inc. in a parallel universe
Let us now imagine a parallel universe in which everything is the same as in ours, except that we have magically substituted
all the debt of Toy Inc. with equity. In this parallel universe, Toy Inc. is entirely equity financed, and we will henceforth call
it all-equity Toy Inc. The pro-forma financial statements of all-equity Toy Inc. are very similar to those of Toy Inc. As in the
previous case, a drop in sales results in a loss and entails a decrease in total assets.
All-equity Toy Inc.: Pro-forma income statement
Today Next year: sales up 20%, costs up 10% Next year: sales down 20%, costs down 10%
Sales $5,000.00 $6,000.00 $4,000.00
(Costs) $3,500.00 $3,850.00 $3,150.00
(Depreciation) $1,000.00 $1,000.00 $1,000.00
EBIT $500.00 $1,150.00 -$150.00
(Interest) $0.00 $0.00 $0.00
EBT $500.00 $1,150.00 -$150.00
(Tax) $170.00 $391.00 $0.00
Net income $330.00 $759.00 -$150.00
Addition to RE $214.50 $493.35 -$150.00
Dividend $115.50 $265.65 $0.00
All-equity Toy Inc.: Pro-forma balance sheet
Today
Next year:
sales up 20%,
costs up 10%
Next year:
sales down 20%,
costs down 10%
Today
Next year:
sales up 20%,
costs up 10%
Next year:
sales down 20%,
costs down 10%
Cash $100.00 $1,503.35 $950.00 A/P $0.00 $0.00 $0.00
Inventory $500.00 $550.00 $500.00 N/P $0.00 $0.00 $0.00
A/R $400.00 $440.00 $400.00 Current liabilities $0.00 $0.00 $0.00
Current assets $1,000.00 $2,493.35 $1,850.00
Long-term debt $0.00 $0.00 $0.00
Gross fixed assets $3,000.00 $3,000.00 $3,000.00 Other long-term $0.00 $0.00 $0.00
Depreciation $1,000.00 $2,000.00 $2,000.00 Outstanding shares $3,285.50 $3,285.50 $3,285.50
Net fixed assets $2,000.00 $1,000.00 $1,000.00 Retained earnings $214.50 $707.85 $64.50
Other assets $500.00 $500.00 $500.00 Owner's equity $3,500.00 $3,993.35 $3,350.00
Total assets $3,500.00 $3,993.35 $3,350.00 Total L&E $3,500.00 $3,993.35 $3,350.00
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