UGBA 180 Lecture Notes - Lecture 10: Tax Rate, Accrual, Financial Instrument
25 Jun 2018
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Lecture 10: Financial Leverage
Why do Investors Use Debt?
1. Insufficient equity capital
a. May also choose to invest cash elsewhere
2. Tax benefits
a. Recall: mortgage interest payments deductible
3. Take advantage of financial leverage
What is Financial Leverage?
●Financial leverage:
○Benefits that may result for an investor who borrows money at an interest rate
lower than the expected rate of return on funds invested in a property
■Borrow @10% and invest @20%
●Financial leverage magnifies the return on equity
With and Without Loans Comparison IRRs and Total Overview
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Document Summary
Insufficient equity capital: may also choose to invest cash elsewhere, tax benefits, recall: mortgage interest payments deductible, take advantage of financial leverage. Benefits that may result for an investor who borrows money at an interest rate lower than the expected rate of return on funds invested in a property. Financial leverage magnifies the return on equity. With and without loans comparison irrs and total overview. Can have positive leverage on btirr but not atirr. But after tax leverage depends on the after tax cost of debt. After tax cost of debt = before tax cost of debt * (1-t) In our ex atirr = 0. 1*(1-0. 28) = 7. 2% Leverage increases btirr if the unleveraged btirr > interest rate on debt. Btirr e = btirr p + (btirr p - btirr d) * (d/e) Btirr e = leveraged btirr = btirr on equity invested. Btirr p = unleveraged btirr = btirr on total investment. Btirr d = interest rate on debt.
