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Determination of change in Return on Equity (ROE)

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. Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more. Under Plan B the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, 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?
a. 3.83%
b. 4.02%
c. 4.22%
d. 4.43%
e. 4.65%

This was the only question in a long list of questions which I completely failed to comprehend on three levels: 1) I did not understand how you could arrive at just one answer when Quigley Company proposes two plans; 2) I was uncertain where the 25% debt financing and the 75% common equity belong in which profitability ratio, and 3)-I wasn't sure when to deduct for both the 35% tax rate and the 8.8% interest. If willing, I was hoping one of your fine OTA's could explain the ratio calculations used in solving this problem. Thanks

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Determination of change in Return on Equity (ROE) are provided.

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DETERMINATION OF CHANGE IN RETURN ON EQUITY (ROE)
Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $301,770, operating costs ...

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  • M. Sc., London South Bank University
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