You were hired as the CFO of a new company that was founded by three professors at your university.

The company plans to manufacture and sell a new product, a cell phone that can be worn like a wrist

watch. The issue now is how to finance the company, with equity only or with a mix of debt and

equity. The price per phone will be $250.00 regardless of how the firm is financed. The expected

fixed and variable operating costs, along with other data, are shown below. How much higher or lower

will the firm's expected ROE be if it uses 60% debt rather than only equity, i.e., what is ROE

L

- ROE

U

?

0% Debt, U

60% Debt, L

Expected unit sales (Q)

24,000

24,000

Price per phone (P)

$250.00

$250.00

Fixed costs (F)

$1,000,000

$1,000,000

Variable cost/unit (V)

$200.00

$200.00

Required investment

$2,500,000

$2,500,000

% Debt

0.00%

60.00%

Debt, $

$0

$1,500,000

Equity, $

$2,500,000

$1,000,000

Interest rate

NA

10.00%

Tax rate

35.00%

35.00%