Capital Structure

Complete and upload the excel file and answer the following questions:

a.Complete the following tables: Leverage Ratio

(Debt/Total Assets)

$10,000,000 0% 20% 40%

Total assets $10,000,000 $10,000,000 $10,000,000

Debt (12%)

Equity

Total liabilities and equity

Expected operating

income (EBIT) $2,500,000 $2,500,000 $2,500,000

Less: Interest (@ 12%)

Earnings before tax

Less: Income tax @ 40%

Earnings after tax

Return on equity

Effect of a 20% Decrease in EBIT to $2,000,000

Leverage Ratio

(Debt/Total Assets)

0% 20% 40%

Expected operating

income (EBIT) $2,000,000 $2,000,000 $2,000,000

Less: Interest (@ 12%)

Earnings before tax

Less: Income tax @ 40%

Earnings after tax

Return on equity

Effect of a 20% Increase in EBIT to $3,000,000

Leverage Ratio

(Debt/Total Assets)

0% 20% 40%

Expected operating

income (EBIT) 3,000,000 $3,000,000 $ 3,000,000

Less: Interest (@ 12%)

Earnings before tax

Less: Income tax @ 40%

Earnings after tax

Return on equity

1. Determine the percentage change in return on equity of a 20 percent decrease in expected EBIT from a base level of $2.5 million with a debt-to-total-assets ratio of:i.0%ii.20%iii.40%
2. Determine the percentage change in return on equity of a 20 percent increase in expected EBIT from a base level of $2.5 million with a debt-to-total-assets ratio of:i.0%ii.20%iii.40%
3. Which leverage ratio yields the highest expected return on equity?
4. Which leverage ratio yields the highest variability (risk) in the expected return on equity?