Question

Consider the following case of Lost Pigeon Aviation 

Suppose Lost Pigeon Aviation 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 25,000 shares. 

• The company incurs a tax rate of 40%. 

If the project is financed using 10 Pigeon Aviation's return on equity (ROE) on the project equity capital, then 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 50% equity capital. The interest rate on the company's debt will be 13%. Because the company will finance only 50% of the project with equity, it will have only 12,500 shares outstanding. Lost Pigeon Aviation's ROE and the company's EPS will be if management decides to finance the project with 50% debt and 50% equity. 

As a firm uses more debt in Its capital structure, lenders will usually _______ the interest rate charged.

Answer 1