Leverage Analysis
Week 4 – LHCO 213
Working with the Working Capital Accounts
ASSETS
What we own to
conduct our CAPITAL
business – make
Sales! What we owe Creditors
& Investors.
The source of our assets.
Debt – mostly interest-
bearing and Equity
Leverage
The use of Debt to finance Assets, as opposed
to using Equity.
Debt is “OPM” other people’s money; Equity is
our money.
Use OPM to “lever”, increase the ability of our
money to carry Assets.
Unlevered Levered
10
10
20 20
0 0
30 30
0 30
10 10
0 200
10
200
0
(50)
(50) 150
200 10
20 20
Sales 10,200
SG&A Expenses (9,800)
Interest 10% (120)
PreTax 280
Tax 30% (84)
Net Income 196 1.9%
Shares 180
Price ?
EPS $ 1.09
Assets 5,000
=
Liabilities 1,200
Equity 3,800
1 After
Before Divest
Divestitures
Sales 10,200 (1,200) 9,000
SG&A Expenses (9,800) 1,300 (8,500)
Interest 10% (120) 50 (70)
PreTax 280 150 430
Tax 30% (84) (45) (129)
Net Income 196 1.9% 105 301 3.3%
Shares 180 180
Price
EPS $ 1.09 $ 1.67
Assets 5,000 (750) 4,250
=
Liabilities 1,200 (500) 700
Equity 3,800 (250) 3,550
1 After
Before Divest Recapitalization
Divestitures
Sales 10,200 (1,200) 9,000 9,000
SG&A Expenses (9,800) 1,300 (8,500) (8,500)
Interest 10% (120) 50 (70) 8% (230)
PreTax 280 150 430 270
Tax 30% (84) (45) (129) (81)
Net Income 196 1.9% 105 301 3.3% 189 2.1%
Shares 180 180 100
Price
EPS $ 1.09 $ 1.67 $ 1.89
Assets 5,000 (750) 4,250 4,250
=
Liabilities 1,200 (500) 700 2,700
Equity 3,800 (250) 3,550 1,550
What If’s
Assume that in the Divestiture,
Goodyear gains $50M and reduces
expenses by an extra $50M but the new
bank debt costs 10 percent and the tax
rate is 40%.
After Divestitures Recapitalization
9000 9000
(8,500) (8,500)
(70) 0.1 (270)
430 230
(172) (92)
258 2.87% 138 1.53%
180 100
1.43 1.38
4250 4250
700 2700
3550 1550