Last year Charter Corp. had sales of $300,000, operating costs of $265,000, and year-end assets of $200,000. The debt-to-total-assets ratio was 25%, the interest rate on the debt was 10%, and the firm's tax rate was 35%. The new CFO wants to see how the ROE would have been affected if the firm had used a 60% debt ratio. Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?

Question

Last year Charter Corp. had sales of $300,000, operating costs of $265,000, and year-end assets of $200,000.  The debt-to-total-assets ratio was 25%, the interest rate on the debt was 10%, and the firm's tax rate was 35%.  The new CFO wants to see how the ROE would have been affected if the firm had used a 60% debt ratio.  Assume that sales and total assets would not be affected, and that the interest rate and tax rate would both remain constant. By how much would the ROE change in response to the change in the capital structure?