This week's assignment will examine how using debt can affect an organization's returns, further increasing returns during periods of growth, but further decreasing returns during recessionary periods. As you can see by looking at the table below, we have two firms, one of which does not use debt (Firm U) and a firm that uses debt (Firm L).

For this week's assignment, solve for each organization's returns during periods of expected growth and during periods of bad growth. Assume a 40% tax rate and a 15% interest rate. Recall from prior chapters, return on equity (ROE) can be solved for as net income divided by equity, or NI/E (as you know, E can be found in each firm's balance sheet found above its income statement). As you can see, debt is truly a double-edged sword!

PS - Please highlight all four answers and show your calculations. Thanks!

*Note: use problem set data (just the mini balance sheets and income statements under the problem set link) to solve for return on equity, or net income / equity. So, when solving for net income, one firm will have to subtract out an interest expense due to the usage of debt, which will not change during good and bad times, but sales will. For the other firm, you'll perform the same ROE calculation, but there will be no interest expense.

Firm U (unleveraged)					Firm L (Leveraged)
Current Assets	50	Debt	0		Current assets	50	Debt	50
Fixed assets	50	Equity	100		Fixed assets	50	Equity	50
Total assets	100		100		Total assets	100		100
	Expected	Bad				Expected	Bad
Sales	100	82.5			Sales	100	82.5
Oper Costs	70	80			Oper Costs	70	80
EBIT	30	2.5			EBIT	30	2.5
Interest					Interest
EBT	30	2.5			EBT	22.5	-5
Taxes					Taxes
Net Inc					Net Inc