Consider the following case: Blue Sky Drone Company is considering a project that will require $650,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 40%. Assuming that the project generates an expected EBIT (earnings before interest and taxes) of $160,000, then Blue Sky's anticipated ROE (return on equity) for the project will be: 0 11.03% 0 14.77/o O 12.56% 0 16.25% In contrast, assume that the project's EBIT is only $45,000. When calculating the tax effects, assume that the entire Blue Sky Drone Company will earn a large, p05itive income this year. The resulting ROE will be Now consider the case of the Purple Whale Foodstuffs Inc.: Purple Whale Foodstuffs Inc. is considering implementing a project that is identical to that being evaluated by Blue Skyalthough Purple Whale wants to finance the $650,000.00 in additional assets using 50% equity and 50% debt capital. The interest rate on Purple Whale's new debt is expected to be 11%, and the project is forecasted to generate an EBIT of $160,000. As a result, the project is expected to generate a ROE of Now assume that Purple Whale finances the same project with 50% debt and 50% equity capital, but expects it to generate an EBIT of only $45,000. Further assume that the company as a whole will generate a large, positive income this year, such that any loss generated by the project (with its resulting tax saving) will be offset by the company's other (positive) income. Remember, the interest rate on Purple Whale's debt is 11%. Under these conditions, it is reasonable to expect that Purple Whale will generate a ROE of: O 2.2 1% O 2. 13/o O 1.870/0 o 1.7/o/o Given the ROErelated findings above for both Blue Sky and Purple Whale, answer the following question: increases decreases I ' I I V I manager is more likely to use debt in an effort to boost profits. 0 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. I The greater a firm's chance 0 he its optimal debt ratio will be