You are given the following information concerning a firm:

Assets required for operation: ............................$5,000,000

Revenues: ...............................................................$8,400,000

Operating expenses: .............................................$7,900,000

Income tax rate: ......................................................40%.

Management faces three possible combinations of financing:

1. 100% equity financing

2. 30% debt financing with a 6% interest rate

3. 60% debt financing with a 6% interest rate

a. What is the net income for each combination of debt and equity financing?

b. What is the return on equity for each combination of debt and equity financing?

c. If the interest rate had been 12 percent instead of 6 percent, what would be the return on equity for each combination of debt and equity financing?

d. What is the implication of the use of financial leverage when interest rates change?