Q2

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 $200,000 in assets The project is expected to produce earnings before interest and taxes (EBIT) of $50,000 . Common equity outstanding will be 30,000 shares The company incurs a tax rate of 35% In If the project is financed using 100% dauity 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 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 15,000 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 Typically, using financial leverage will project's expected ROE