If the project is financed using 100% equity capital, then Green Rabbit Transportation Inc.’s return on equity (ROE) on the project will be . In addition, Green Rabbit’s earnings per share (EPS) will be . Alternatively, Green Rabbit Transportation Inc.’s CFO is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the company’s debt will be 12%. Because the company will finance only 50% of the project with equity, it will have only 7,500 shares outstanding. Green Rabbit Transportation Inc.’s ROE and the company’s EPS will be if management decides to finance the project with 50% debt and 50% equity. Typically, using financial leverage will a project’s expected ROE.
If the project is financed using 100% equity capital, then Green Rabbit Transportation Inc.’s return on equity (ROE) on the project will be . In addition, Green Rabbit’s earnings per share (EPS) will be . Alternatively, Green Rabbit Transportation Inc.’s CFO is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the company’s debt will be 12%. Because the company will finance only 50% of the project with equity, it will have only 7,500 shares outstanding. Green Rabbit Transportation Inc.’s ROE and the company’s EPS will be if management decides to finance the project with 50% debt and 50% equity. Typically, using financial leverage will a project’s expected ROE.
Chapter14: Capital Structure Management In Practice
Section: Chapter Questions
Problem 34P
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Question
The impact of financial leverage on return on equity and earnings per share
Consider the following case of Green Rabbit Transportation Inc.:
Suppose Green Rabbit Transportation Inc. is considering a project that will require $200,000 in assets.
| • | The company is small, so it is exempt from the interest deduction limitation under the new tax law. |
| • | The project is expected to produce earnings before interest and taxes (EBIT) of $45,000. |
| • | Common equity outstanding will be 15,000 shares. |
| • | The company incurs a tax rate of 25%. |
If the project is financed using 100% equity capital, then Green Rabbit Transportation Inc.’s return on equity (ROE) on the project will be . In addition, Green Rabbit’s earnings per share (EPS) will be .
Alternatively, Green Rabbit Transportation Inc.’s CFO is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the company’s debt will be 12%. Because the company will finance only 50% of the project with equity, it will have only 7,500 shares outstanding. Green Rabbit Transportation Inc.’s ROE and the company’s EPS will be if management decides to finance the project with 50% debt and 50% equity.
Typically, using financial leverage will a project’s expected ROE.
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