Problem:
The D Company wishes to calculate next year's return on equity under different leverage ratios. D's total assets are $14 million, and its average tax rate is 40 percent. The company is able to estimate next year's earnings before interest and taxes (EBIT) for three possible states of the world: $4.2 million with a 0.2 probability, $2.8 million with a 0.5 probability, and $700,000 with a 0.3 probability. Calculate D's expected return on equity for each of the following leverage ratios and evaluate the results:
Leverage
________
(Debt/Total Assets) Interest Rate
0% ------
10 9%
50 11
60 14