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What is the impact of leverage on a firms profits

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Question: Bob and Sarah are thinking of starting up a business. They will need to purchase around 100k of equipment, supplies, and for working capital.

They have the money to purchase everything, but would like to save some cash for other project.

They both want you to figure out the cost and benefits of different approaches to the business.

Test out two scenarios, one with 80% debt, and one with 25% debt.

They anticipate an EBIT loss of 15k in year 1, break-even in year 2, 30k gain in year 3, and 50k gain in year 4.

What is the best option?

The interest rate is 7%, and the tax rate is 21%

In both cases, they will issue 100 shares in total.

What is the impact of leverage on a firm's profits and return on investment?

Which is the better option?

Reference no: EM132756240

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