Central City Construction (CCC) needs $1 million of assets to get started, and it expects to have a basis earning power ratio of 20%. CCC will own no securities, so all of it income will be operating income. If it so chooses, CCC can finance up to 50% of its assets with debt, which will have an 8% interest rate. Assuming a 40% tax rate on all taxable income , what is the difference between CCC’s expected ROE if it finances with 50% debt versus its expected ROE if it finances entirely with common stock?
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