The effect of leverage

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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?          
                                   
                                   
                                   
                                   
                                   
                                   
                                   
                                   

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