PM CDT Activity Informaton t: Chapter 4 Homework, part 2 \"- graded Assignment S

Question

PM CDT Activity Informaton t: Chapter 4 Homework, part 2 "- graded Assignment Score: 0.00% Save Submit Assignment for Grading Check My Work O Click here to read the eBook: Profitability Ratios RETURN ON EQUITY Commonwealth Construction (CC) needs $3 million of assets to get started, and it expects to have a basic O : earning power ratio of 10%. CC will own no securities, so all of its income will be operating income. If it so chooses, CC can finance up to 50% of its assets with debt, which will have an 7% 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 a 30% tax rate on all taxable income, what is the difference between CC's expected ROE if it finances these assets with 50% debt versus its expected ROE if it finances these assets entirely with common stock? Round your answer to two decimal places Check My Work On Icon Ke sveSubmit

Explanation / Answer

Funds Needed = $3,000,000

IF all equity, return = 10%

i.e. $300,000

Which means Income before Tax = 300,000/0.7

=$428,571.43

Now, Debt - $1500,000 and Equity = $1500,000

EBIT = $428,571.43

Less: Interest@ 7% = $105,000

Earning for Equity = $323571.43

BEPS = 323571.43/1,500,000*100 = 21.57%

Hence, required difference = 21.57% - 10% = 11.57%

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