pital Structure and Leverage ded Assignment |Read Chapter 14| Back to Assignment

Question

pital Structure and Leverage ded Assignment |Read Chapter 14| Back to Assignment Due Sunday 07.01.1 Attempts: Keep the Highest: 4 2. Business and financial risk Aa A 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 $400,000 in assets. 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 40%. If the project is financed using 100% equity capital, then Lost Pigeon Aviation's return on equity (ROE) on the project will be In 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 S0% equity capital. The interest rate on the company's debt will be 13%. Because the company mir finance only 50% of the projedt with equity, it will have only 10,000 shares outstanding. Lost Pigoon Aviation's ROE and the company's EPS will be equity if management decides to finance the project with S0% debt and 50% Typically, the use of financial leverage will make the probobility distribution of ROIC MacBook F4 FS

Explanation / Answer

Question - 1 ........... (a) ROE = EBIT ( 1 - Tax rate ) / Equity * 100 = 50000 ( 1 - 0.40 ) / 400,000 * 100 = 7.5 %

(b) EPS = Profit after tax / No of shares Outstanding = 30000 / 20000 = 1.5 per share.

Question - 2

ROE = ( EBIT - Interest) ( 1 - Tax rate) / Equity * 100

= ( 50000 - 26000) ( 1 - 0.40) / 200,000 * 100 = 7.20 %

EPS = ( EBIT - Interest) ( 1 - Tax rate) / Number of shares outstanding

= ( 50000 - 26000) ( 1 - 0.40) / 10000 = 1.44

ROE and companys EPS will be 7.20 % and 1.44     

Question - 3 ,,,,, Profitability distribution of ROIC Unfavorable

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