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 $1 million of assets to get started, and it expects to have a basic 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 35% of its assets with debt, which will have an 9% 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 35% tax rate on all taxable income, what is the difference between CC's expected ROE if it finances these assets with 35% 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.

Expert Solution & Answer

Trending nowThis is a popular solution!

See solution

Check out sample textbook solution

Students have asked these similar questions

Commonwealth Construction (CC) needs $1 million of assets to get started, and it expects to have a basic 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 35% of its assets with debt, which will have an 9% 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 35% tax rate on all taxable income, what is the difference between CC's expected ROE if it finances these assets with 35% debt versus its expected ROE if it finances these assets entirely with common stock? Round your answer to two decimal places.

Commonwealth Construction (CC) needs $3 million of assets to getstarted, and it expects to have a basic earning power ratio of 35%. CC will own no securities,all of its income will be operating income. If it so chooses, CC can finance up to 30%of its assets with debt, which will have an 8% interest rate. If it chooses to use debt, thefirm will finance using only debt and common equity, so no preferred stock will be used.Assuming a 40% tax rate on taxable income, what is the difference between CC’s expectedROE if it finances these assets with 30% debt versus its expected ROE if it finances theseassets entirely with common stock?

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 20%. CCC will own no securities, so all of its income will be operating income. If it so chooses, CCC can finance up to 50% 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 willbe used. Assuming a 40% tax rate on all taxable income, what is the difference between CCC’s expected ROE if it finances these assets with 50% debt versus its expected ROE if it finances these assets entirely with common stock?