Question

Consider the following case of Green Rabbit Transportation Inc.: Suppose Green Rabbit Transportation Inc. is considering a project that will require $350,000 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 40%. If the project is financed using 100% equity capital, then Green Rabbit Transportation Inc.'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.'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 11%. Because the company will finance only 50% of the project with equity, it will have only 15,000 shares outstanding. Green Rabbit Transportation Inc.'s ROE and the company's EPS will be ________ if management decides to finance the project with 50% debt and 50% equity.Typically, the use of financial leverage will make the probability distribution of ROIC ______

Answer 1

Answer:1%

ROE = Profit after interest and tax divided by total equity

$30000/30000shares= 100%

2. EPS = Profit after interest, tax and preference dividend divided by total common stocks

$30,000/30,000 = 100%

3. If Finance with debts

ROE = $26700/30000= 89%

EPS =&26700/30000= 89%

The use of financial leverage will make the probability distribution of ROIC to change.