Consider an all-equity firm that is contemplating going into debt. The market value of equity is calculated as Free Cash Flow/required rate of return.

You can choose if you want to include a tax rate or not. If you include a tax rate, choose 30%.

CurrentProposed

Assets$10,000$18,000

Debt$0$8,000

Equity $10,000$10,000

Debt/Equity ratio0.001.00

Interest raten/a7%

Shares outstanding500500

Share price$20$20

(a) If the required rate of return on unlevered equity is 10%, fill out the following table for the company before the debt is issued:

RecessionExpectedExpansion

EBIT$500 $1,000$1,500

Interest000

Net income

EPS

ROA

ROE

(b) If the company adds the proposed amount of debt and EBIT is expected to expand proportionally, fill out the table in (a) after the debt is issued.

(c) If an investor is not happy with the debt the company added, show the steps the investor can take to do homemade "un-leverage" and earn the same ROA and ROE as in part (a). Set up a table to show that the unleveraged works.