Assignment 5 Chapter 16: Capital Structure Decisions 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: Blue Sky Drone Company is considering a project that will require $600,000 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 $140,000, then Blue Sky's anticoated ROE (retum on equity) for the project will be 13.06% O 16.33% O 12.255 11439 in contrast, assume that the project is only $40,000. When calculating the tax effects, assume that the entire ne Sky Drone Company will can a large, positive Income this year. The resulting ROE will be New consider the case of the Hungry Whelectronics Company Mungry Whale Electronics Company is considering implementing project that is identical to that being evaluated by Moe sky.although Hungry Whate wants to finance the 1500,000.00 in additional sets using 50% equity and Sons de capital, The Interest rate on Hungry whale's new debe is expected to be, and the project is forecasted to benetan bort of $140.000. As a result, the project is expected to generate a Roof Now assume that Hungry whale finances the same project with 50debt and souty capital, but expects it to generate an EBIT of only $40,000, Further sume that the company as a whole will generate a large poove Income this year, such that any loss generated by the padectwith its resting tax saving) will be offset by the company's her (positive) income, Karember, the interest rate on Hunor whale's debt is 13%. Under these conditions it is reasonable to expect that Hungry wale weate a Rot of 0.22 O 0.21 Given the ROE-related findings above for both Blue Sky and Hungry Whale, answer the following question: The use of financial leverage a firm's expected ROE the probability of a large loss, and consequently the risk borne by the firm's stockholders. The greater a firm's chance of bankruptcy, the its optimal debt ratio will be manager is more likely to use debt in an effort to boost profits. Grade It Now Save & Cond