Suppose Happy Turtle Transportation Company is considering a project that will require $300,000 in assets. • The project is expected to produce earnings before interest and taxes (EBIT) of $60,000.
• Common equity outstanding will be 15,000 shares.
• The company incurs a tax rate of 35%.
If the project is financed using 100% equity capital, then Happy Turtle’s return on equity (ROE) on the project will be . In addition, Happy Turtle’s earnings per share (EPS) will be .
Alternatively, Happy Turtle Transportation Company'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 7,500 shares outstanding. Happy Turtle Transportation Company'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 prabability distribution of ROIC.