Kizspy Question: 45
(Choose 1 answer)
Covent Gardens Inc. is considering two financial plans for the coming year. Management expects sales to be
$300,000, operating costs to be $265,000, assets to be $200,000, and its tax rate to be 35 percent. Under Plan
A it would use 25 percent debt and 75 percent common equity. The interest rate on the debt would be 8.8
percent, but under a contract with existing bondholders the times interest earned (TIE) ratio would have to be
maintained at or above 4.5. 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. 3.45%
B. 2.59%
C. 15.85%
D. 13.26%
