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

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Finance

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

Consider the following case of Purple Panda Importers:

Suppose Purple Panda Importers is considering a project that will require $400,000 in assets.

The project is expected to produce earnings before interest and taxes (EBIT) of $45,000.
Common equity outstanding will be 10,000 shares.
The company incurs a tax rate of 40%.

If the project is financed using 100% equity capital, then Purple Pandas return on equity (ROE) on the project will be . In addition, Purple Pandas earnings per share (EPS) will be .

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 12%. Because the company will finance only 50% of the project with equity, it will have only 5,000 shares outstanding. Purple Panda Importerss ROE and the companys EPS will be if management decides to finance the project with 50% debt and 50% equity.

Typically, using financial leverage will a projects expected ROE.

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