You have been hired by a new firm that is just being started. The CFO wants to finance with 60% debt, but the president thinks it would be better to hold the percentage of debt in the capital structure (wd) to only 10%. The company is small, so it is not subject to the interest deduction limitation. Other things held constant, and based on the data below, if the firm uses more debt, by how much would the ROE change, i.e., what is ROEHigher – ROELower? Do not round your intermediate calculations.
| Operating Data |
|
Other Data |
| Capital |
$4,000 |
|
Higher wd |
60% |
| ROIC = EBIT(1 – T)/Capital |
12.00% |
|
Higher interest rate |
13% |
| Tax rate |
25% |
|
Lower wd |
10% |
|
|
|
Lower interest rate |
9% |
