. Consider two hypothetical firms: Firm U, which uses no debt financing, and Firm L, which uses $1,000,000 of 5 percent debt. Both firms have $2,500,000 in assets, a 21 percent tax rate, and an expected EBIT of $250,000.

1. Construct partial income statements, which start with EBIT, for the two firms.
2. Now calculate ROE for both firms.

3. What happens to ROE for Firm U and Firm L if EBIT falls to $110,000? What does this imply about the impact of leverage on risk and return?