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I need question c) Arrow Technology, Inc. (ATI) has total assets of $10 million and expected operating income (EBIT) of $2.5 million. If ATI uses debt in its capital structure, the cost of
this debt will be 12 percent per annum.
a. Complete the following table:
Leverage Ratio (Debt/Total Assets)
0% 25% 50%
Total assets ______ ______ ______
Debt (at 12% interest) ______ ______ ______
Equity ______ ______ ______
Total liabilities and equity ______ ______ ______
Expected operating income (EBIT) ______ ______ ______
Less: Interest (at 12%) ______ ______ ______
Earnings before tax ______ ______ ______
Less: Income tax at 40% ______ ______ ______
Earnings after tax ______ ______ ______
Return on equity ______ ______ ______
Effect of a 20% Decrease in EBIT to $2,000,000
Expected operating income (EBIT) ______ ______ ______
Less: Interest (at 12%) ______ ______ ______
Earnings before tax ______ ______ ______
Less: Income tax at 40% ______ ______ ______
Earnings after tax ______ ______ ______
Return on equity ______ ______ ______
Effect of a 20% Increase in EBIT to $3,000,000
Expected operating income (EBIT) ______ ______ ______
Less: Interest (at 12%) ______ ______ ______
Earnings before tax ______ ______ ______
Less: Income tax at 40% ______ ______ ______
Earnings after tax ______ ______ ______
Return on equity ______ ______ ______
b. Which leverage ratio yields the highest expected rate of return on equity.
c. Which leverage ratio yields the highest variability of expected return on equity.
d. Which is the flaw related to the problem related to cost of capital and leverage?
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