Your counterparts on the management team are concerned about the recent economic volatility and its impact on the performance of the business given its inherent business risk and fixed financing costs. Given these concerns and the data below, address the issues of business risk and financial risk. [Note that this discussion should include the concepts of operating leverage (DOL) and financial leverage (DFL).] 

 Using the framework of a partial income statement, clearly demonstrate the impact of financial leverage on the firm's ROIC, ROA and ROE. Explain how the results also demonstrate the relationship between the business and financial risk the firm faces. 

 

Data:

Consider two hypothetical firms:  Firm U, which uses no debt financing, and Firm L which uses $10,000 of 8% debt. Both firms have $20,000 in TNOC, a 25% tax rate, and an expected EBIT of $3,000. Construct a partial income statement for each firm starting with EBIT. What happens to the metrics in this example if the EBIT decreases to $2,100?