Consider the following case of Happy Turtle Transportation Company: Suppose Happy Turtle Transportation Company is considering a project that will require $350,000 in assets. • The company is small, so it is exempt from the interest deduction limitation under the new tax law. • The project is expected to produce earnings before interest and taxes (EBIT) of $40,000. • Common equity outstanding will be 10,000 shares. • The company incurs a tax rate of 25%. If the project is financed using 100% equity capital, then Happy Turtle Transportation Company’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 10%. Because the company will finance only 50% of the project with equity, it will have only 5,000 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. When a firm uses debt financing, the business risk exposure for the firm’s common shareholders will .

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 21P: Your division is considering two investment projects, each of which requires an up-front expenditure...

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Consider the following case of Happy Turtle Transportation Company:

Suppose Happy Turtle Transportation Company is considering a project that will require $350,000 in assets.

•	The company is small, so it is exempt from the interest deduction limitation under the new tax law.
•	The project is expected to produce earnings before interest and taxes (EBIT) of $40,000.
•	Common equity outstanding will be 10,000 shares.
•	The company incurs a tax rate of 25%.

If the project is financed using 100% equity capital, then Happy Turtle Transportation Company’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 10%. Because the company will finance only 50% of the project with equity, it will have only 5,000 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.

When a firm uses debt financing, the business risk exposure for the firm’s common shareholders will .

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