Income Statement

($ millions) Year 0

Revenues (Sales) 800

Operating Costs 300

Depreciation 100

Amortization 0

EBIT

Interest Expense _

EBT 220

Taxes (25%) ____

Net Income $

Dividends

Add to RE 120

Balance Sheet

Cash $ 100

Receivables 200

Inventories 150

Current Assets 450

Net Fixed Assets 100

Total Assets 550

Accounts Payable 50

Notes Payable 10

Accruals 30

Current Liabilities 90

Bonds 110

Common Stock 150

Retained Earnings ____

Total Liab & Eq $

2. Central City Construction Company, which is just being formed, needs $1 million of assets, and it expects to have a basic earning power ratio of 20 percent. Central City will own no securities, so all of its income will be operating income. If it chooses to, Central City can finance up to 50 percent of its assets with debt, which will have an 8 percent interest rate. Assuming a 25 percent federal-plus-state tax rate on all taxable income, what is the difference between its expected ROE if Central City finances with 50 percent debt versus its expected ROE if it finances entirely with common stock?