To develop an example that can be presented to CD?s management as an illustration, consider two hypothetical firms, Firm U, with zero debt financing and Firm L, with $10,000 of 12% debt. Both firms have $20,000 in total assets and a 40% federal-plus-state tax rate, and they have the following EBIT probability distribution for next year:

Firm U $20,000 $20,000 Firm L $20,000 $10,000 $20,000 $20,000 $20,000 $20,000 $20,000 $10,000 $20,000 $10,000 Assets Equity 0.25 Probability 0.25 0.50 0.25 0.25 0.50 $ 6,000 4,000 $ 2,000 $ 9,000 $ 9,000 6,000 $ 3,000 $.6.000 4,000 $.2.000 $12,000 8,000 $ 4,000 $12,000 8,000 $ 4,000 1,200 $ 2,800 1,120 $ 1.680 Sales Oper. costs 6,000 $ 3,000 EBIT Int. (12%) 1,200 $ 800 $ $ 3,000 $ 4,000 $ 2.000 EBT Taxes (40%) 1,600 $ 2.400 800 1,200 $ 1.800 320 $ 480 $ Net income S1.200 BEP 10.0% 15.0% 20.0% 10.0% 20.0% 16.8% ROE 6.0% 9.0% 12.0% 4.8% 1.7x TIE 3.3x 15.0% EBEP) EROE) ECTIE) 9.0% 10.8% 2.5x 3.5% OBEP 2. 1% 4.2% OROE 0.6x OTIE