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    Financial Leverage Problem 20-03: A B C D

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    marriette joy abad
    The document discusses how financial leverage affects the return on common stock for different firms (A-D) using varying amounts of debt, preferred stock, and equity financing. As debt levels increase from firm A to C, the return on common stock decreases because higher interest expenses reduce earnings available to shareholders. Firm C has a higher interest rate due to taking on more financial risk. Firm D has a lower return than firms B or C because preferred stock dividends are not tax deductible like interest expenses. Equity financing involves the least risk for firms.

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    Financial Leverage Problem 20-03: A B C D

    Uploaded by

    marriette joy abad
    18 views2 pages
    The document discusses how financial leverage affects the return on common stock for different firms (A-D) using varying amounts of debt, preferred stock, and equity financing. As debt levels increase from firm A to C, the return on common stock decreases because higher interest expenses reduce earnings available to shareholders. Firm C has a higher interest rate due to taking on more financial risk. Firm D has a lower return than firms B or C because preferred stock dividends are not tax deductible like interest expenses. Equity financing involves the least risk for firms.

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    Financial Leverage 20- 03

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    The document discusses how financial leverage affects the return on common stock for different firms (A-D) using varying amounts of debt, preferred stock, and equity financing. As debt levels increase from firm A to C, the return on common stock decreases because higher interest expenses reduce earnings available to shareholders. Firm C has a higher interest rate due to taking on more financial risk. Firm D has a lower return than firms B or C because preferred stock dividends are not tax deductible like interest expenses. Equity financing involves the least risk for firms.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    18 views2 pages

    Financial Leverage Problem 20-03: A B C D

    Uploaded by

    marriette joy abad
    The document discusses how financial leverage affects the return on common stock for different firms (A-D) using varying amounts of debt, preferred stock, and equity financing. As debt levels increase from firm A to C, the return on common stock decreases because higher interest expenses reduce earnings available to shareholders. Firm C has a higher interest rate due to taking on more financial risk. Firm D has a lower return than firms B or C because preferred stock dividends are not tax deductible like interest expenses. Equity financing involves the least risk for firms.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 2

    Financial Leverage

    Problem 20-03

    Fill in the table using the following information.


    Assets required for operation: $9,600
    Firm A uses only equity financing
    Firm B uses 30% debt with an 8% interest rate and 70% equity
    Firm C uses 50% debt with a 10% interest rate and 50% equity
    Firm D uses 50% preferred stock financing with a dividend rate of 10% and 50% equity financing
    Earnings before interest and taxes: $960
    If your answer is zero, enter "0". Round your answers for monetary values to the nearest cent. Round your answers for percentage values to one decimal place.

    A B C D
    Debt
    $   $   $   $  
    Preferred stock
    $   $   $   $  
    Common stock
    $   $   $   $  
    Earnings before interest and taxes $960.00 $960.00 $960.00 $960.00
    Interest expense
    $   $   $   $  
    Earnings before taxes
    $   $   $   $  
    Taxes (40% of earnings)
    $   $   $   $  
    Preferred stock dividends
    $   $   $   $  
    Income available to common stockholders
    $   $   $   $  
    Return on common stock   %
      %   %   %
    What happens to the common stockholders' return on equity as the amount of debt increases? Why is the rate of interest greater in case C? Why
    is the return lower when the firm uses preferred stock instead of debt?

    Other things equal, the return on common stock    as the firm uses financial leverage. As the firm

    becomes   financially leveraged (  in financial risk), the rate of interest will increase. The
    return is lower when the firm uses preferred stock instead of debt because the   are not tax

    deductible as opposed to the   .


    Which type of financing involves less risk for the firm?

    Assuming a comparable use,   is less risky to the firm.

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