2. Business and financial risk

The impact of financial leverage on return on equity and earnings per share

Consider the following case of Happy Turtle Transportation Company:

Suppose Happy Turtle Transportation Company 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 $55,000.
• Common equity outstanding will be 30,000 shares.
• The company incurs a tax rate of 25%.

If the project is financed using 100% equity capital, then Happy Turtle Transportation Company's return on equity (ROE) on the project will be

. In addition, Happy Turtle's earnings per share (EPS) will be

Alternatively, Happy Turtle Transportation Company'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 13%. Because the company will finance only 50% of the project with equity, it will have only 15,000 shares outstanding. Happy Turtle Transportation Company'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.

2. Business and financial risk The impact of financial leverage on return on equity and earnings per share Consider the following case of Happy Turtie Transportation Company: Suppose Happy Turtle Transportation Company 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 $55,000. - Common equity outstanding will be 30,000 shares. - The company incurs a tax rate of 25%. If the project is financed using 100% equity capital, then Happy Turtle Transportation Companys return on equity (ROE) on the project will be. In addition, Happy Turtie's eornings per share (EPS) will be Alternatively, Happy Turtle Transportation Company's Cro is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the company's debt will be 13\%. Because the company will finance only so\% of the project with equity. it will have only 15,000 shares outstanding. Happy Turtie Transportation Company's foE and the company's EPS will be decides to finance the project with 50% debt and 50% equity Typically, using financial ieverage will a projects expected ROE