The difference in return on equity with 30% debt and entirely financed with common stock. Return on equity: Return on equity is the return from the equity. It is the ratio of net income and shareholders’ equity. This ratio measures the performance of the company and tells how well the company is performing. This ratio is used to compare own firm with competitors.

Question

Commonwealth Construction (CC) needs $3 million of assets to get started, and it expects to have a basic earning power ratio of 30%. CC will own no securities, so all of its income will be operating income. If it so chooses, CC can finance up to 60% of its assets with debt, which will have an 12% 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 60% debt versus its expected ROE if it finances these assets entirely with common stock? Round your answer to two decimal places.

Answer 1

Question

Chapter 4, Problem 16P

Summary Introduction

To identify: The difference in return on equity with 30% debt and entirely financed with common stock.

Return on equity:

Return on equity is the return from the equity. It is the ratio of net income and shareholders’ equity. This ratio measures the performance of the company and tells how well the company is performing. This ratio is used to compare own firm with competitors.

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