You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV
You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $172,000. The company is small, so it is not subject to the interest deduction limitation. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU? Do not round your intermediate calculations.
| | 0% Debt, U | | 60% Debt, L |
| Oper. income (EBIT) | $172,000 | | $172,000 |
| Required investment | $2,000,000 | | $2,000,000 |
| % Debt | 0.0% | | 60.0% |
| $ of Debt | $0.00 | | $1,200,000 |
| $ of Common equity | $2,000,000 | | $800,000 |
| Interest rate | NA | | 10.00% |
| Tax rate | 25% | | 25% |
Confu Inc. expects to have the following data during the coming year. The company is small, so it is not subject to the interest deduction limitation. What is the firm's expected ROE?
| Capital | $168,000 | | Interest rate | 6% |
| Debt/Capital, book value | 65% | | Tax rate | 25% |
| EBIT | $35,000 | | | |
