5. 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 $300,000 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 35%. In addition, Free If the project is financed using 100% equity capital, then Free Spirit's return on equity (ROE) on the project will be 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 12%. 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. As a firm uses more debt in its capital structure, lenders will usually increase the interest rate charged