Consider the following case of Lost Pigeon Aviation:

Suppose Lost Pigeon Aviation is considering a project that will require $\backslash (\backslash$$ $350,000\backslash )$ 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 $\backslash (\backslash$$ $40,000\backslash ).$

$-$ Common equity outstanding will be $10,000$ shares.

$-$ The company incurs a tax rate of $\backslash (25\backslash \%\backslash ).$

If the project is financed using $\backslash (100\backslash \%\backslash )$ equity capital, then Lost Pigeon Aviation's return on equity $($ROE$)$ on the project will be addition, Lost Pigeon's earnings per share $($EPS$)$ will be

Alternatively, Lost Pigeon Aviation's CFO is also considering financing the project with $\backslash (50\backslash \%\backslash )$ debt and $50\backslash \%$ equity capital. The interest rate on the company's debt will be $\backslash (13\backslash \%\backslash ).$ Because the company will finance only $\backslash (50\backslash \%\backslash )$ 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 $\backslash (50\backslash \%\backslash )$ debt and $\backslash (50\backslash \%\backslash )$ equity.

When a firm uses debt financing, the business risk exposure for the firm's common shareholders wi