5. The effect of financial leverage on ROE Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Red Snail Satellite Company is considering a project that will require $500,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 30%. Assuming that the project generates an expected EBIT (earnings before interest and taxes) of $150,000, then Red Snail's anticipated ROE (return on equity) for the project will be: 21.00% 23.10% 15.75% 22.05% In contrast, assume that the project's EBIT is only $60,000. When calculating the tax effects, assume that the entire Red Snail Satellite Company will earn a large, positive income this year. The resulting ROE will be Now consider the case of the Black Sheep Broadcasting Company: Black Sheep Broadcasting Company is considering implementing a project that is identical to that being evaluated by Red Snail-although Black Sheep wants to finance the $500,000.00 in additional assets using 50% equity and 50% debt capital. The interest rate on Black Sheep's new debt is expected to be 10%, and the project is forecasted to generate an EBIT of $150,000. As a result, the project is expected to generate a ROE of