172 Southwest Physicians a medical group practice is just be

17.2 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? 72 Rivercide Memoeio g m.

Solution

1)ROE refers Return On Equity

2)it measures the efficiency of share holders equity

3) it is the relationship between the net income and share holders equity.

4) it measures the profitability of the company with the book value of share holders equity

5) the following equation is helf ful to calculate ROE

ROE= net income / share holders equity *100

Answer

In a given problem , it will need $2million of total assets and

it generates total revenue of $3 million

Expected profit margin is 5percent

Net profit margin is un effected

so net profit = $3million *5/100 =$0.15 million

Alternative 1 if the firm finances entirely with equity then total equity capital $2 million

ROE =net profit /share holders equity *100

=$0.15 million / $2 million *100

= 7.5 percentage

Alternative 2

If the firm finances 50 percent of assets by bank loan then capital structure is 50 percent debt and 50 percent equity

Total capital = 1millon debt + 1million equity =2million total capital

share holders equity is 1million under alternative 2

ROE =$.015 million / $1 million *100

= 15 percentage

Thank you