Question 1: Arrow Technology (ATI) has total assets of $10 million and expected operating income (EBIT) of $2.5 million. If ATI uses debt in its capital structure, the cost of debt will be 12% per annum.

Complete the following table and report the return on equities for each the three scenarios. You can use the attached excel template to complete the calculations (_fmg_homework6_excel.xlsx Download _fmg_homework6_excel.xlsx).

Based on your calculation, answer the following questions.

	Leverage ratios (Debt / Total assets)
EBIT = 2,500,500	0%	25%	50%
Total assets	??	??	??
Debt (12%)	??	??	??
Equity	??	??	??
Total liabilities and equity	??	??	??
Expected operating income (EBIT)	??	??	??
Less: Interest (@ 12%)	??	??	??
Earnings before tax	??	??	??
Less: Income tax @ 40%	??	??	??
Earnings after tax	??	??	??
Return on equity	??	??	??
Effect of a 20% Decrease in EBIT to $2,000,000	0%	25%	50%
Expected operating income (EBIT)	??	??	??
Less: Interest (@ 12%)	??	??	??
Earnings before tax	??	??	??
Less: Income tax @ 40%	??	??	??
Earnings after tax	??	??	??
Return on equity	??	??	??
Effect of a 20% Increase in EBIT to $3,000,000	0%	25%	50%
Expected operating income (EBIT)	??	??	??
Less: Interest (@ 12%)	??	??	??
Earnings before tax	??	??	??
Less: Income tax @ 40%	??	??	??
Earnings after tax	??	??	??
Return on equity	??	??	??

1. What is the earning after tax, when debt/asset ratio = 25% and EDIT = 2,500,000?

a. 2,000,000

b. 1,320,000

c. 1,140,000

d. 1,500,000

2 . When the EBIT drops from 2,500,000 to 2,000,000

change of ROE (leverage = 0%) = 3%.

change of ROE (leverage = 50%)=

a. -6%

B. -4%

c. -2%

d. -8%

3. When the EDIT increases from 2,500,000 to 3,000,000

change in ROE (leverage = 0%) = 3%

change in ROE (leverage = 25%) = ?

a. 4%

b. 3%

c. 6%

d. 5%

4. From the above calculation, we observe.

With the higher financial leverage, when EDIT increases, ROE increases ____; when EDIT decreases, ROE decreases ___.

a. less, less

b. less, more

c. more, more

d. more, less