Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Consider the following case of Lost Pigeon Aviation: Suppose Lost Pigeon Aviation is considering a project that will require $350,000 in assets. The company is

Consider the following case of Lost Pigeon Aviation:

Suppose Lost Pigeon Aviation is considering a project that will require $350,000 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 $40,000.
Common equity outstanding will be 25,000 shares.
The company incurs a tax rate of 25%.

If the project is financed using 100% equity capital, then Lost Pigeon Aviations return on equity (ROE) on the project will be (6.86%,8.57%, 9.00%, 8.14%) . In addition, Lost Pigeons earnings per share (EPS) will be ($1,20, $.84, $1.32, $1.02, $1.08)

Alternatively, Lost Pigeon Aviations CFO is also considering financing the project with 50% debt and 50% equity capital. The interest rate on the companys debt will be 10%. Because the company will finance only 50% of the project with equity, it will have only 12,500 shares outstanding. Lost Pigeon Aviations ROE and the companys EPS will be (10.12% and $1,28; respectively , 10.60% and $1.42;respectively, 9.64% and $1.35; respectively, 7,23% and $1,08; respectively) if management decides to finance the project with 50% debt and 50% equity.

When a firm uses debt financing, the business risk exposure for the firms common shareholders will (increase or decrease)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Enterprise Risk Management In Finance

Authors: David L. Olson, Desheng Dash Wu

1st Edition

1349691038, 978-1349691036

More Books

Students also viewed these Finance questions