2. Business and financial risk The impact of financial leverage on return on equity and earnings per share Consider the following case of Free Spirit Industries Inc.: Suppose Free Spirit Industries 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 $50,000. Common equity outstanding will be 10,000 shares. The company incurs a tax rate of 40%. In If the project is financed using 100% equity capital, then Free Spirit Industries Inc.'s return on equity (ROE) on the project will be addition, Free Spirit's earnings per share (EPS) will be Alternatively, Free Spirit Industries 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 13%. Because the company will finance only 50% of the project with equity, it will have only 5,000 shares outstanding. Free Spirit Industries Inc.'s ROE and the company's EPS will be if management decides to finance the project with 50% debt and 50% equity. When firm uses debt financing, the business risk exposure for the firm's common shareholders will In If the project is financed using 100% equity capital, then Free Spirit Industries Inc.'s return on equity (ROE) on the project will be addition, Free Spirit's earnings per share (EPS) will be 7.71% ng. Free Alternatively, Free Spirit Industries Inc.'s CFO is also considering financing the project with 50% debt and 50% equity capital. The 7.28% ate on the company's debt will be 13%. Because the company will finance only 50% of the project with equity, it will have only 5,000 shares 8.57% Spirit Industries Inc.'s ROE and the company's EPS will be if management decides to final foject with 50% debt and 50% equity. 9.00% When firmucos debt financing the business ricavaocure for the firm's common shareholders will The project is expected to produce earnings $2.70 erest and taxes (EBIT) of $50,000. Common equity outstanding will be 10,000 st $2.40 The company incurs a tax rate of 40%. $3.00 $2.85 $2.25 Spirit Industries Inc.'s return on equity (ROE) on the project will be In If the project is financed using 100% equity capital, th addition, Free Spirit's earnings per share (EPS) will be 8.87% and $2.94, respectively n equity (ROE) on the project will be . In If the project is financed using 100% equity capital, then F addition, Free Spirit's earnings per share (EPS) will be 7.94% and $2.78, respectively Alternatively, Free Spirit Industries Inc.'s CFO is also consi 10.27% and $3.43, respectively % debt and 50% equity capital. The interest rate on the 9.34% and $3.27, respectively equity, it will have only 5,000 shares outstanding. Free if management decides to finance the project with company's debt will be 13%. Because the company will fin Spirit Industries Inc.'s ROE and the company's EPS will be 50% debt and 50% equity. Alternatively, Free Spirit Industries 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 13%. Because the company will finance only 50% of the project with equity, it will have only 5,000 shares outstanding. Free Spirit Industries Inc.'s ROE and the company's EPS will be if increase nt decides to finance the project with 50% debt and 50% equity. decrease When a firm uses debt financing, the business risk exposure for the firm's common shareholders will
