Now, to develop an example that can be presented to Bernies management to illustrate the effects of financial leverage, consider two hypothetical firms: Firm U, which uses no debt financing, and Firm L, which uses $100,000 of 4 percent debt. Both firms have $500,000 in assets, a 22 percent tax rate, and an expected EBIT of $80,000.

1a )Construct partial income statements, which start with EBIT, for the two firms.

1b) Now calculate ROE for both firms.

1 c) What does this example illustrate about the impact of financial leverage on ROE?