The impact of financial leverage on return on equity and earnings per share

Consider the following case of Green Rabbit Transportation Inc.:

Suppose Green Rabbit Transportation Inc. is considering a project that will require $$250,000$ 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 $$60,000.$

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 Green Rabbit Transportation Inc.$\text{'}$s return on equity $($ROE$)$ on the project will be

$.$ In addition, Green Rabbit's earnings per share $($EPS$)$ will be

Alternatively, Green Rabbit Transportation Inc.$\text{'}$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 $10\%.$ Because the company will finance only $50\%$ of the project with equity, it will have only $10,000$ shares outstanding.

Green Rabbit Transportation Inc.$\text{'}$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

a project's expected ROE.