This document discusses how leverage affects firm earnings. It provides examples of a firm's earnings with no leverage and with borrowing $40 at 10% interest. The examples show that using leverage can increase return on equity but also increases risk, as higher expenses lead to a greater decline in returns when leveraged compared to unleveraged. Leverage is beneficial when returns exceed interest costs, but disadvantageous when expenses rise and returns fall below interest.
6. 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.
7. 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.
8. 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?
9. f. How does the use of financial leverage effect a firm's
earnings?
When is using financial leverage beneficial?
When is it disadvantageous?