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Frank Smith Plumbing Company Case Study

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Limited Leverage is good for Business
The degree of financial leverage in Frank Smith Plumbing Company is a key fundamental aspect to the loan which it seeks to obtain. It is critical in the sense that it will indicate the financial risks associated with the company based on its financial performance as well as its capital structure. The application of limited financial leverage is thus essential to this business portfolio since it will determine the sensitivity of the company’s available cash position and the given fluctuations in its earnings before interest and taxes (EBIT). Financial leverage has value when it comes to the tax shield and when the assets are being purchased especially with the debt capital. In both instances prudence in …show more content…

In addition, she should explain that simply a call will not suffice the bank manager to issue the loan to the business based on friendly terms but the financial statements will be valued and examined to detail to determine the true financial position and the feasibility of the venture in paying the loan in future.
Analyze whether the investment in the truck is profitable.
Investment in the truck is a major asset in terms of capturing large economies of scale. This would enable the business to produce more units of timber at lower costs and the same time meeting the small costs of maintenance in the timber industry. However, looking at the business situation, the NPV is negative a figure less than zero hence prompting that the business is not in a position to acquire the truck and still remain operational.
According to "Return On Investment " (2016), " If an investment does not have a positive ROI, or if an investor has other opportunities available with a higher ROI, then these ROI values can instruct him or her as to which investments are preferable to others ” (para. …show more content…

The negative NPV, less than zero profitability (PI) and less IRR as compared to the cost of capital of the company indicates that the business will continue its operations into the foreseeable future with difficulties facing financial crisis.
As a potential investor judging by the situation of the business it is advisable that Frank closes his business at the present to increase chances of benefiting now since if he disposes the assets, he can use the reserves to start something else as opposed to sticking with the business and experience much turmoil due to the risks that he will contain such as purchasing the truck and far ahead having the financial burden of having to service the loan. According to "Complete Guide To Corporate Finance" (2016), "NPV is the difference between the present value of cash inflows and the present value of cash outflows. NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, the project should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative” (para.

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