Financial leverage

Explain why Limited Leverage is good for Business

Financial leverage is good for business as it assist a business acquire additional assets through use of debt. The more debt financing a company uses the better its financial leverage. This assist a business increase the size or profitability and in Frank Smiths business, acquisition of a truck (asset) to generate more income. It is important to understand that financial leverage comes at a cost, the revenues generated might not cover the interest payments. Many factors can make interest rate higher than usual making payments difficult that is why it is important to limit leverage to reduce debt.

Show the profitability of the project so that Stephanie can convince her Father to purchase the truck by borrowing money.

According to Stephanie her father’s income is suitable to get a good loan from the bank at a good rate. Creditors rely on business financial condition for risk purposes and profitability of their investments. Using an income statement a bank can evaluate past income performances and observe if there is uncertainty of future cash flows. In Frank smiths financial statement we can observe that the company has enough cash to pay for expense and asset.

According to the excel sheet attached the profit index is 1.10% and this ascertains the exact rate of return of the project. This means that the project can be accepted because a profitability index of 1 indicates break even and attractiveness of project. Stephanie can show Frank Smith how much money he can make after borrowing money. The profitability ratio is important and is determined if the Net Present Value is positive thus showing that the profitability index would be higher.