Quigley Inc.is considering two financial plans for the coming year.Management expects sales to be $300,000,operating costs to be $265,000,assets (which is equal to its total invested capital)to be $200,000,and its tax rate to be 35%.Under Plan A it would finance the firm using 25% debt and 75% common equity.The interest rate on the debt would be 8.8%,but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 5.5.Under Plan B,the maximum debt that met the TIE constraint would be employed.Assuming that sales,operating costs,assets,total invested capital,the interest rate,and the tax rate would all remain constant,by how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculations.
A) 1.04%
B) 1.32%
C) 1.52%
D) 1.11%
E) 1.13%

Question

Quizplus · Accepted Answer

11ea856c_8bf5_69cd_9aec_618b55a6c5f5_TB1222_00 ?
Sales
Constant
$300,000
$300,000
Operating costs
Constant
265,000
265,000
EBIT
Constant
$35,000
$35,000
Interest
4,400
6,364
Taxable income
$30,600
$28,636
Taxes
10,710
10,023
Net income
$19,890
$18,614
ROE = NI / Equity =
13.26%
14.58%
TIE = EBIT/Interest =
7.95
Minimum TIE
5.50
$ of Interest consistent with minimum TIE = EBIT/Min TIE =
$6,364
Max debt = Interest/interest rate =
$72,314
Change in ROE
1.32%
?