MS&E 147 Chapter Notes - Chapter 2: Sole Proprietorship, Retained Earnings

• School: Stanford University
• Department: MS&E - Mgmt Science & Engineering
• Course: MS&E 147
• Professor: Anat Admati

Document Summary

Leverage creates opportunities for borrower but also magnifies risk (double edged. Individuals and businesses can afford things much more expensive and they can afford sword) Upside is great: leverage magnifies borrower profit. Downside: magnifies losses, more borrowing, increased this danger. Corporations can fund with debt but can also issue equity shares. Kate buys house worth 300,000, not enough so takes mortgage up to 270,000, contributes 30,000 as down payment. Asset: entire 300,000 (house price), mortgage is debt, equity is the down payment. Suppose house goes up in value by 5%, next year. Pays 270,000 mortgage from selling house, kate left with 45,000, 15,000 more than. If goes down in value 5%, house worth 285,000, pays back 270,000 mortgage, now has loss of 15,000. Underwater: if house goes under 15%, then cannot even pay back mortgage after selling house. If kate started with greater initial equity, leverage effect both ways is less drastic.