Back to category: Business Limited version - please login or register to view the entire paper. Financial Leverage Financial Leverage Financial leverage is using OPM (Other People's Money) to improve Return On Equity (ROE.) rather than utilizing owners equity. If a company can borrow money at a rate lower than the return on assets or ROI then the owners' equity position will be improved. This occurs because less of the equity is required to purchase assets. Improving Return on Equity Consider a company who has expected earnings before interest and taxes (EBIT) of $500,000 and needs to obtain $1M in new financing either through the sale of 50,000 shares of common stock or obtaining a long-term loan at 10% interest. Total assets of the company are $4.2M and the corporate tax rate is 30%. (Kuhlemeyer, 2001) Without Leverage With Leverage Assets 4,200,000 4,200,000 EBIT $500,000 $500,000 Interest 0 $100,000 EBT $500,000 $400,000 Taxes $150,000 $120,000 Net Income $350,000 $280,000 Shares Outstanding ($20/share) 100,000 50,000 ... Posted by: Sandeep Jador Limited version - please login or register to view the entire paper. |
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