RETURN ON EQUITY commonwealth construction cc needs $1 million of assets to get
ID: 1170071 • Letter: R
Question
RETURN ON EQUITY commonwealth construction cc needs $1 million of assets to get started, and it expects to have a basic earning power ratio of 10% CCw a no sec es so a ofts ncome wil e operating ncome fts) oses CC can finance up to 5596 of its assets with debt which will have an 8% interest rate. If it chooses to use debt, the firm will finance using only debt and common equity, so no preferred stock will be used. Assuming 35% tax rate on all taxable income, what is the difference between CC's expected ROE if it inances these assets with 55% debt versus its expected ROE ir it inances these assets entirely with common stock? Round your answer to two decimal places.Explanation / Answer
basic earning power = EBIT/TOTAL ASSETS * 100
10 = EBIT/1000000*100
THEREFORE EBIT = 100000
PARTICULAR ONLY EQUITY DEBT & EQUITY EBIT 100000 100000 LESS : INTEREST (550000 X 8%) 0 44000 EBT 100000 56000 TAX (35%) 35000 19600 NET INCOME 65000 36400 TOTAL ASSETS 1000000 1000000 EQUITY 1000000 450000 DEBT (8%) (55% OF TOTAL ASSETS) 0 550000 ROE = NET INCOME/EQUITY*100 65000/1000000*100 36400/450000*100 ROE (%) 6.5% 8.09% DIFFERENCE IN ROE = 8.09% - 6.5% = 1.59% ANSWERRelated Questions
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