The Digital Sound Corporation has 1 million shares of common stock outstanding at \($10\) per share. It is an all-equity firm. Susan Wang is CEO at Wang Finance Ltd. She wants to acquire a stake of 1 percent of the firm but has not decided among the three possible financing choices. She can borrow 20 percent, 40 percent, or 60 percent of the money she needs at a constant interest rate of 10 percent a year. The return on equity of the Digital Sound Corporation is 15 percent. Assume that she is in an MM no-tax world.

a. How much dollar return can Susan expect to earn from her investment each year under each of the three financing alternatives, respectively?

b. What are Susan’s returns on equity on each financing choice, respectively?

c. From parts (a) and (b), what inference can she draw about the return on equity of a leveraged firm?