consider the case The impact of financial leverage on return on equity and earni
ID: 2771651 • Letter: C
Question
consider the case The impact of financial leverage on return on equity and earnings per share Consider this case: Suppose Sonaiya Development Group ts COnMmig a project that will require $200,000 in assets. The project is expected to produce an EBIT (earnings before Interest aid taxes of $55.000 The project wll be financed with 100% equity Common cqmty outstanding ml be 20,000 shares. The company faces a tax rate of 35% Using the preceding information, what will Sonaiya Development Group's return on equity (ROE) be for this project? 21.46% 16.09% 18.77% 17.88% Sonaiya Development Group's earnings per share (EPS) will be if it finances this Sonaiya Development Group's earnings per share (EPS) will be if it finances this project with 100% equity. Sonaiya Development Group's CFO is also considering financing this project with 50% debt and 50% equity The interest rate on the company's debt will be 12%. Because the company mi finance only 50% of the project with equity, it will have only 10,000 shares outstanding What will the ROE be on this project if tne company decides to finance the project with 50% debt and 50% equity 23.76% 32.14% 27.95% 33.54% Sonaiya Development Group's EPS will be if it finances this project with 50% equity and 50% debt. Typically, using financial leverage will a project's expected ROE.Explanation / Answer
Return on equity:
= Net income×(1-35%)÷Equity
= $55,000×(1-35%)÷$200,000
ROE = 17.88%
EPS:
= Net income×(1-35%)÷Number of shares
= $55,000×(1-35%)÷20,000
= $1.79 per share
Return on equity:
= Net income÷Equity
= ($55,000-$12,000)×(1-35%)÷$100,000
ROE = 27.95%
EPS:
= Net income×(1-35%)÷Number of shares
= ($55,000-$12,000)×(1-35%)÷10,000
= $2.80 per share
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