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Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-One of the reasons cited as a contributing factor in the financial meltdown of 2008 was the very high leverage ratios of major banking institutions. Which of the following outcomes would NOT occur if bank leverage were reduced?

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Lowering leverage ratios would actually make bank financing less expensive as it would decrease the risk of insolvency and default, resulting in lower borrowing costs. Choice B and D are correct, as a drop in asset value would have less impact on the bank's solvency and decreasing leverage would decrease the riskiness of the bank's equity. Choice C is partially correct, as a decrease in leverage would result in a lower return on equity, but it would also decrease the riskiness of the bank's equity.

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