Finance

 

The Effect of Leverage on Firm Earnings                                  
                                       
A firm needs $100 to start and has the following expectations:                               
                                       
                                       
Sales $200                                    
Expenses $185                                    
Tax rate  33% of earnings                                    
                                       
                                       
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.          
                                       
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.    
                                       
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.            
                                       
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.            
                                       
e. Did the returns decline more when financial leverage was or was not utilized?                            
                                       
f. How does the use of financial leverage effect a firm’s earnings?  When is using financial leverage beneficial?  When is it disadvantageous?