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Southwest Physicians, a medical group practice,

Southwest Physicians, a medical group practice, is just being formed. It will need $2 million of total
assets to generate $3 million in revenues. Furthermore, the group expects to have a profit margin of 5
percent. The group is considering two financing alternatives. First, it can use all-equity financing by
requiring each physician to contribute his or her pro rata share. Alternatively, the practice can finance
up to 50 percent of its assets with a bank loan. Assuming that the debt alternative has no impact on the
expected profit margin, what is the difference between the expected ROE if the group finances with 50
percent debt versus the expected ROE if it finances entirely with equity capital?

Solution Summary

The difference between the expected ROE if the group finances with 50 percent debt versus the expected ROE if it finances entirely with equity capital is depicted here.

$2.19