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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.

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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