Problem 4-15 Return on Equity Central City Construction (CCC) needs $1 million o

Question

Problem 4-15
Return on Equity

Central City Construction (CCC) needs $1 million of assets to get started, and it expects to have a basic earning power ratio of 15%. CCC will own no securities, so all of its income will be operating income. If it chooses to, CCC can finance up to 50% of its assets with debt, which will have an 10% interest rate. Assuming a 30% tax rate on all taxable income, what is the difference between CCC's expected ROE if it financeswith 50% debt versus its expected ROE if it finances entirely with common stock? Round your answer to two decimal places.

___________ %

Explanation / Answer

Return on equity without financing: Net income = .15*1,000,000 = 150,000. ROE = 150,000/1,000,000 = .15. To find return on equity with financing, net income = 150,000

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