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    Capital Structures to Maximize the Return on Equity

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    ROE = ROIC + (ROIC - i')D/E. Assume your company
    has a return on invested capital of 12%. Also assume your borrowing costs will
    rise as you employ more debt in your capital structure.

    a) Calculate ROE for the following combinations of capital structure and
    borrowing costs.

    i) D/E = 0.5, borrowing cost = 7%

    ii) D/E = 1.0, borrowing cost = 9%

    iii) D/E = 2.0, borrowing cost = 13%

    b) What capital structure maximizes ROE?

    c) Explain, in a sentence or two, what is happening in the three cases in part (a). Use non-technical language, so that even your boss could understand your explanation!

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    Solution Preview

    Finance
    ROE = ROIC + (ROIC - i')D/E. Assume your company has a return on invested capital of 12%. Also assume your borrowing costs will rise as you employ more debt in your capital structure.

    a) Calculate ROE for the following combinations of capital structure and
    borrowing costs.

    i) D/E = ...

    Solution Summary

    This solution is comprised of a detailed explanation to calculate ROE for the following combinations of capital structure and borrowing costs, answer what capital structure maximizes ROE, and explain, in a sentence or two, what is happening in the three cases in part (a).

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