Question

Commonwealth Construction (CC) needs $2 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 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 will be used. Assuming a 40% 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.

Answer 1