Basic income statement and balance sheet information is given below for six different cases. For each case, the assets are financed with a mix of non-interest-bearing liabilities, 10% interest bearing liability and stockholders' equity. In all cases, the income tax rate is 40%.

a. For each case, calculate the return on equity (ROE), return on assets (ROA) and return on financial leverage (ROFL).

b. Consider cases A, B and C. How does increasing leverage affect the three ratios? Why does the ROE grow from case A to case C?

c. Consider cases C and D. When does leverage work in favor of shareholders? Does that hold for case E?

d. Case F has two types of liabilities. How does ROA compare to the rate on interest-bearing liabilities? Does leverage work in favor of the shareholders? Why?

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Case D A E Average assets... Non-interest-bearing liabilities Interest-bearing liabilities.... Average shareholders' equity.. 1,000 1,000 1,000 1,000 1.000 1,000 200 200 250 500 500 300 1,000 750 500 500 800 500 Earnings before interest and taxes (EBIT). 120 120 120 80 100 80