Your firm, General Hospital currently uses zero debt financing. Its operating income (EBIT) is $1 million and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing bearing an interest rate of 8 percent.

a. What impact would the new capital structure have on the firms net income, total dollar return to investors, and ROE?

b. Redo the analysis, but now assume that the debt financing would be 15 percent.