Unformatted text preview: stock is riskier if the firm uses debt. • At the expected level of EBIT, ROE L > ROE U . • The use of debt will increase roe only if ROA exceeds the after-tax cost of debt. Here ROA = unleveraged roe = 9.0% > r d (1 - t) = 12%(0.6) = 7.2%, so the use of debt raises roe. • Finally, note that the TIE ratio is huge (undefined, or infinitely large) if no debt is used, but it is relatively low if 50 percent debt is used. The expected tie would be larger than 2.5 × if less debt were used, but smaller if leverage were increased....
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- Spring '08