5. Business and financial risk The impact of financial leverage on return on equity and earnings per share Consider the following case of Lost Pigeon Aviation: Suppose Lost Pigeon Aviation is considering a project that will require $400,000 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 30%. If the project is financed using 100% equity capital, then Lost Pigeon's return on equity (ROE) on the project will be 8.75% Pigeon's earnings per share (EPS) will be $2.98 Alternatively, Lost Pigeon Aviation'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 11%. Because the company will finance only 50% of the project with equity, it will have only 5,000 shares outstanding. Lost Pigeon Aviation's ROE and the company's EPS will be if management decides to finance the project with 50% debt and 50% equity. As a firm uses more debt in its capital structure, lenders will usually In addition, Lost the interest rate charged