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?
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?
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter16: Capital Structure Decisions
Section: Chapter Questions
Problem 3MC
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Commonwealth Construction (CC) needs $3 million of assets to get
started, 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, the
firm will finance using only debt and common equity, so no
Assuming a 40% tax rate on taxable income, what is the difference between CC’s expected
ROE if it finances these assets with 30% debt versus its expected ROE if it finances these
assets entirely with common stock?
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