Question
Consider the following case of Purple Panda Importers: Suppose Purple Panda Importers is considering a project that will require $400,000 in assets. The company is
Consider the following case of Purple Panda Importers:
Suppose Purple Panda Importers is considering a project that will require $400,000 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 $50,000. | |
Common equity outstanding will be 20,000 shares. | |
The company incurs a tax rate of 25%. |
If the project is financed using 100% equity capital, then Purple Panda Importerss return on equity (ROE) on the project will be (10.79%, 7.97%, 10.32%, or 9.38%) . In addition, Purple Pandas earnings per share (EPS) will be ($1.88, $1.41, $1.97, $1.79, or $2.07?) .Alternatively, Purple Panda Importerss 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 10,000 shares outstanding. Purple Panda Importerss ROE and the companys EPS will be 11.25% and $2.25, respectively, 13.50% and $2.59, respectively, 9.56% and $1.91, respectively, OR 12.94% and $2.48, respectively?
if management decides to finance the project with 50% debt and 50% equity.
Typically, using financial leverage will (INCREASE OR DECREASE?) a projects expected ROE.
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