The company for which you work has a significant investment in the stock of Star-Beasts, Inc. (SBI), which currently manufactures one kind of toy, a large and lovable stuffed monster. SBI is considering expansion of its production facilities and would finance the expansion with long-term borrowing at an expected interest rate of 10%. The market would seem to support the manufacture and sale of 20% more monsters at the current profit margin. The added facilities would cost approximately $3.4 million. Alternatively, SBI could add one of two new lines: a mechanical dragon or a game called Starship Troopers. The numbers below indicate current operating results and projections for the effects of added facilities for manufacturing the new lines. The numbers do not include interest on the new facilities or the company’s 35% income tax rate.

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A. In addition to showing the current income statement, prepare pro forma income statements for SBI under each of the three strategies: expanding manufacturing of the current product and adding each of the new lines.

B. Determine the return on assets for the current situation and for each of the three strategies.

C. Indicate under which strategy you would feel most confident about the value of your company’s investment, and explain why.


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