Consider the Following Leverage Scenarios: Leverage Scenarios (000s) If Under Certain Circumstances, Financial Leverage Enhances Performance Measured by

question 125

Multiple Choice

Consider the following leverage scenarios: Leverage Scenarios (000s)
$\begin{array}{llll}&\# 1 & \# 2 & \# 3 \\&0 \% \text { Debt } & 50 \% \text { Debt } & 80 \% \text { Deb }\\\text { Capital } & & & \\\text { Debt } & -\$ 1,000 & \$ 1,600 \\\text { Equity } & \$ 2,000 & 1,000 & 400 \\\text { Total capital } & 2,000 & \$ 2,000 & \$ 2,000 \\\text { Shares@ } \$ 10 &200,0007100,000&40,000\\\text { Revenue } & \$ 2,000 & \$ 2,000 & \$ 2,000 \\\text { Less costs/ expenses } & 1,800 & 1,800 & 1,800 \\\text { EBIT } & 200 & 200 & 200 \\\text { Interest expense }(10 \%) & - & 100 & 160 \\\text { EBT } & 200 & 100 & 40 \\\text { Taxes @ 40\% } & 80 & 40 & 16 \\\text { Earnings after tax } & \$ 120 & \$ 60 & \$ 24\\\text { ROE } &6\%&6\%&6\%\\\text { EPS } & \$.60&\$.60&\$.60\end{array}$ If under certain circumstances, financial leverage enhances performance measured by ROE and EPS, why does shifting from equity into debt have no effect in this case?

• A) The company hasn't repurchased enough shares of stock with borrowed money.
• B) The money the company is earning on its capital is exactly what it costs to borrow.
• C) ROCE is too high.
• D) ROCE is equal to the after tax cost of debt.

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Definitions:

Nominal Wages

Wages paid to labor in current currency terms, without adjustment for inflation.

Industrially Advanced

Describes economies that have a significant level of development and industrialization, often characterized by high per capita incomes and widespread infrastructure.

Real Wages

Wages adjusted for inflation, reflecting the actual purchasing power of income earned from work.

Output per Worker

A measure of productivity calculated by dividing total output of goods or services by the number of workers involved in the production.