© 2014 Cengage Learning. All Rights Reserved. Learning Objectives © 2014 Cengage Learning. All Rights Reserved. LO6Identify factors influencing financing decisions. LO7 Analyze the impact of financial leverage.

© 2014 Cengage Learning. All Rights Reserved. Making Financing Decisions ●The ratio of interest and dividend payments to the proceeds from debt and capital financing is called the cost of capital. ●The following factors should be considered in deciding how a business should raise capital. ●Interest rate ●Impact on earnings ●Repayment terms ●Ownership control ●Debt ratio SLIDE 2 LO6 Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Financial Leverage ●The ability of a business to use borrowed funds to increase its earnings is called financial leverage. SLIDE 3 LO7 Lesson 18-4 Outcome 8.00%10.00%12.00%6.00% Operating income$4,000.00$5,000.00$6,000.00$3, Interest expense3, Net income (loss) before federal income tax$800.00$1,800.00$2,800.00(200.00) Federal income tax (25%) (50.00) Net income after federal income tax$600.00$1,350.00$2,100.00(150.00) Investment10, Return on investment6.00%13.50%21.00%–1.5%

© 2014 Cengage Learning. All Rights Reserved. Selecting Financing Methods SLIDE 4 LO7 Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Lesson 18-4 Audit Your Understanding 1.Identify five options available to a business to raise capital. SLIDE 5 ANSWER Lines of credit Notes payable Bonds Common stock Preferred stock Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Lesson 18-4 Audit Your Understanding 2.Identify five factors that a business should consider in deciding how to raise capital. SLIDE 6 ANSWER Interest rates Impact on earnings Repayment terms Ownership control Debt ratio Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Lesson 18-4 Audit Your Understanding 3.What is necessary for financial leverage to increase earnings? SLIDE 7 ANSWER The borrowed funds must be invested in the business to earn income higher than the interest charged on the borrowed funds. Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Lesson 18-4 Audit Your Understanding 4.How might individuals describe a business having a high level of debt? SLIDE 8 ANSWER Highly leveraged or over-leveraged Lesson 18-4

© 2014 Cengage Learning. All Rights Reserved. Lesson 18-4 Audit Your Understanding 5.What might force a corporation to issue additional stock? SLIDE 9 ANSWER The debt ratio of the corporation exceeds its debt ratio benchmark. Lesson 18-4