If the project is financed using 100% equity capital, then Green Rabbit Transportation Inc.'s return on equity (ROE) on the project will be

2. Business and financial risk

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 $350,000 in assets.

• The project is expected to produce earnings before interest and taxes (EBIT) of $40,000.

• Common equity outstanding will be 10,000 shares.

• The company incurs a tax rate of 30%.

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 5,000 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.

Expert Solution

jeff jeffy answered 2 years ago

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