The effect of leverage on firm’s earnings….

/in /by

The effect of leverage on firm’s earnings….

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?