Citizens Electronics has $25 million in assets. Its expected operating income (EBIT) is $4 million, and its marginal tax rate is 40 percent. If Citizens finances 25 percent of its total assets with debt capital, the pretax cost of funds is 10 per- cent. If it finances 50 percent of its total assets with debt capital, the pretax cost of funds is 15 percent.
a. Determine the return on equity under three different capital structures: 0 percent, 25 percent, and 50 percent debt ratios.
b. Determine the return on equity under each of the three different capital structures if expected EBIT decreases by 20 percent.
c. Determine the return on equity under the three different capital structures as the result of the 20 percent increase in expected EBIT.