Integrative problem, answer: Business risk is the uncertainty associated with a firms projection of its future operating income. It also is defined as the risk faced by a firms stockholders if the company uses no debt. A firms business risk is affected by many factors, including: (1) variability in the demand for its output, (2) variability in the price at which its output can be sold, (3) variability in the prices of its inputs, (4) the firms ability to adjust output. Answer: Operating leverage is the extent to which fixed operating costs are used in a firms operations. If a high percentage of the firms total operating costs are fixed, and hence do not decline when demand falls, then the firm is said to have high operating leverage. Other things held constant, the greater a firms operating leverage, the greater its business risk. Pic answer: Financial leverage refers essay to the firms decision to finance with fixed-charge securities, such as debt and preferred stock. Financial risk is the additional risk, over and above the companys inherent business risk, orne by the stockholders as a result of the firms decision to finance with debt. Pic answer: As we discussed above, business risk depends on a number of factors such as sales and cost variability, and operating leverage.
18, and the debt ratio increases. (The debt ratio had been. Under Equity financing the expected eps. 51, the standard deviation. 85, the cv. 15, and the debt ratio decreases. At this interest rate, debt financing provides a higher expected eps than equity financing; however, the debt ratio is significantly higher under the debt financing situation as compared with the equity financing situation. Because eps is not significantly greater under debt financing, but the risk is noticeably greater, equity financing should be recommended.
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If we consider the tax issue alone, interest on debt is tax deductible; thus, the higher the firms tax rate the more beneficial the deductibility of interest. However, competition and business risk have tended to outweigh the tax aspect as we saw from the actual debt ratios of the bell companies. The bell companies and the new at t lowered their debt ratios, for reasons along these lines. 2-11several possibilities exist for the firm, but trying to match the length of the project with the maturity of the financing plan seems to be the best approach. The firm might want to finance the r d with short-term debt and then, if the projects results are successful, to raise the needed capital for production through long-term debt or equity.
Another possibility would lease be to issue convertible bonds, which can be converted to common stock—a lower interest rate would be paid now, and in the future (presumably the stock price will increase with the new process) investors would trade in the bonds for stock. One also should keep in mind that this project, and r d in general, is extremely risky and debt financing might not be available except at extremely high rates. For this reason, many r d companies have low debt ratios, instead paying low dividends and using retained earnings for financing projects. Under Debt financing the expected eps. 78, the standard deviation. 05, the cv.
Thus, financial leverage can influence sales and cost, hence ebit, if excessive leverage causes investors, customers, and employees to be oncerned about the firms future. 12-7Expected eps generally is measured as eps for the coming years, and we typically do not reflect in this calculation any bankruptcy-related costs. Also, eps does not reflect (in a major way) the increase in risk and ks that accompanies an increase in the debt ratio, whereas P0 does reflect these factors. Thus, the stock price will be maximized at a debt level that is lower than the eps-maximizing debt level. 12-8A firm can change the proportion of debt it uses in its capital structure. If the firm has too much (little) debt, it can reduce (increase) the proportion of debt in its capital structure.
We will write a custom essay sample. Stock and Debt or any similar topic only for you. Order now, such as change should decrease the firms wacc, and thus increase its value. 12-9Absolutes optimal capital structure is 40 percent debt ( 20,000,000/50,000,000 because the market price of the companys stock (130. 75) is maximized at this point. 12-10With increased competition after the breakup of at t, the new at t and the seven Bell operating companies business risk increased. With this component of total company risk increasing, the new companies probably decided to reduce their financial risk, and use less debt, to compensate. With increased competition the chance of bankruptcy increases and lowering debt usage makes this less of a possibility.
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However, bankruptcy-related costs begin to be felt after some amount of debt has been employed, and these costs offset the benefits of debt. See figure 12-5 needed in the textbook. 12-5Carson does have leverage because its eps increases by a greater multiple than its sales when sales change. According to the information that is homework given, carsons dtl is 4 20/5. Because we have no information about either the firms operating fixed costs or its fixed financing costs, we cannot state whether the firm has operating leverage, financial leverage, or both. 12-6ebit depends on sales and operating costs that generally are not affected by the firms use of financial leverage, because interest is deducted from ebit. At high debt levels, however, firms lose business, employees worry, and operations are not continuous because of financing difficulties.
Chapter 12 questions 12-1Operating leverage affects ebit and, through ebit, eps. Financial leverage generally has no effect on ebit—it only affects eps, given ebit. 12-2Because firm A has a higher fixed operating costs, its operating income will change by a greater percentage than paper Firm Bs operating income if sales change. Firm A has a higher degree of operating leverage than Firm. 12-3If sales tend to fluctuate widely, then cash flows and the ability to service fixed charges also will vary. Consequently, there is a relatively large risk that the firm will be unable to meet its fixed charges. As a result, firms in unstable industries tend to use less debt than those whose sales are subject to only moderate fluctuations. 12-4The tax benefits from debt increase linearly, which causes a continuous increase in the firms value and stock price.
only have ourselves to blame. In conclusion, although consumers are not forced to buy, most feel compelled to purchase goods and services because they need them and do not want to wait. Rather than saving they go into debt, the most common of which is installment debt. L., Economics : Today and Tomorrow, hesterville, ohio; Glencoe-mcGraw Hill, 1995. Major Growing pains. News and World Report (Oct. News and World Report (Aug. Lee, susan Susan lees abzs of Economics New York ; Poseidon Press, 1987.
Other forms include automobile loans and credit card purchases. Just pick up the write newspaper any time after Christmas and you will find articles on managing your mounting debt from Christmas. Not realizing the extent of the consumers debt is one of the most common types of credit problems. Denial may play a partial role in this problem, but the lack of education seems to be the largest reason for consumer debt. Credit card use is up 20 and a large number of Americans do not know the percentage rate at which the credit card companies charge. Many credit card companies have started personalizing interest rates by not disclosing the interest rate until after the consumer has received the card. By not disclosing the interest rate on the application the credit card companies prohibit the consumer from shopping around for the best deal. You could just say they should cancel the credit card, but did you know several requests for consumer credit could be viewed negatively because the information is reported to the credit bureaus?
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Consumer Debt, essay, research, paper, the reasons we as, americans buy on credit varies, but reviews without it most of us would probably never be able to purchase necessities such as a home or automobile. The nations economy depends on credit, the promise to pay later for goods and services used today ; but along with consumer credit comes consumer debt. With the rise in telemarketing and commercializing. America it is no wonder why Americans feel the impulse to buy now, pay later. The most common form of consumer debt is installment debt, which is when a consumer borrows the money to purchase an item and agrees to repay the loan in equal installments over a fixed period of time. Without installment debt most consumers could not afford to purchase items such as a home. The truth of the matter is that we, as Americans, tend to want to purchase more than we can afford to purchase when we want. But, we can afford to pay it out, over time, in fixed payments. Mortgages, a debt owed on real property, are the latest form of installment debt.