The Effect of Leverage on Firm Earnings |
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A firm needs $100 to start and has the following expectations: |
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Sales |
$200 |
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Expenses |
$185 |
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Tax rate |
33% of earnings |
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a. What are earnings if the firm owners invest the $100 thus utilizing no financial leverage? Tax and net earnings values should be rounded to 2 decimal places. |
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b. If the firm borrows (utilizes financial leverage) $40 of the $100 at an interest rate of 10%, what are the firm’s net earnings? Tax and net earnings values should be rounded to 2 decimal places. |
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c. What is the return on equity when financial leverage is and is not utilized? Why do the returns differ? ROE results should be shown with 2 decimal places. |
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d. If expenses increase to $194, what will be the new return on equity values for each scenario? ROE results should be shown with 2 decimal places. |
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e. Did the returns decline more when financial leverage was or was not utilized? |
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f. How does the use of financial leverage effect a firm’s earnings? When is using financial leverage beneficial? When is it disadvantageous? |
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