for space selection:

Space1: increase/ decrease

Space2: increase/ decrease

Space3: increase/ decrease

Space4: lower/ higher

Space5: A Conservative/ An aggressive

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: Water and Power Co. is considering a project that will require $550,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 30%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $150,000? Water and Power Co. is also considering financing the project with 50% equity and 50% debt. The interest rate on the company's debt will be 11%. What will be the project's ROE if it produces an EBIT of $150,000? 30.5% 29.0% 0 24.4% 32.0% What will be the project's ROE if it produces an EBIT of - $45,000 and it finances 50% of the project with equity and 50% with debt? When calculating the tax effects, assume that Water and Power Co. as a whole will have a large, positive income this year. -22.0% 0 -19.1% -23.9% -20.1% the The use of financial leverage the expected ROE, risk borne by stockholders. The greater the firm's chance of bankruptcy, the is more likely to use debt in an effort to boost profits. the probability of a large loss, and consequently its optimal debt ratio will be. manager