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Butler Corporation produces metal buildings. In the past year it earned a 10% return on its assets base of $10M. Butler needs $10M to expand its operations, and has the option of obtaining none, some, or all of the proceeds from the bank. Currently the company is all equity financed. It expects to be able to maintain its return on assets after the expansion. The bank has indicated that the amount it will charge on the loan will be dependent upon the resultant debt/equity ratio. Specifically, the rates will be 9%, 10%, and 12% for debt to equity ratios less than or equal to 0.5, 1.0, and over 1.0, respectively. Butler's tax rate is 40%.
Calculate Butler's return on equity if the expansion is financed:
1. 50% debt, 50% equity
2. All debt
All other factors held constant, the present value of a given yearly annuity decreases as the number of discounting periods each year increases.
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