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ROE

PROBLEM 2
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?

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