Explain why the costs of debt and equity are expected to increase as leverage increase?
Explain why the costs of debt and equity are expected to increase as leverage increase?
Homework Answers
As leverage increases, the riskiness of the firm increases as higher leverage means more cash flows required to service debt. As riskiness increases there is higher chance of firm not able to generate sufficient cash flows. Hence, cost of debt increases. Cost of equity increases as well because equity is residual claimants and if the cash flow is not enough to service debt then equity will get 0
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Explain why the costs of debt and equity are expected to
increase as leverage increase?
1. Explain why the costs of debt and equity are expected to increase as leverage increase?...
1. Explain why the costs of debt and equity are expected to increase as leverage increase? (Note: We didn't cover this directly in class, but we talked about this indirectly. Hint: It has to do with risk) 2. If the Debt-to-Asset ratio is .46, what is the Debt-to-Equity ratio? 3. Suppose a farm business indicates an average cost of farm debt of 12%, a rate-of-return on farm assets of 15%, and a debt-to-equity ratio of 1.0. What is the firm's...
When both debt and equity become riskier due to an increase in the firm's leverage, the...
When both debt and equity become riskier due to an increase in the firm's leverage, the firm remains worth exactly the same and stays exactly as risky (in a perfect market) Conceptually, what would it take for the firm to become worth more and/or safer even when both debt and equity become riskier due to an increase in the firm's leverage? Q 16.29
HELP ME PLEASE! 24. Consider the following leverage scenarios Leverage Scenarios (000s) #2 50% Debt #1 0% Debt #3 80% Debt Capital Debt Equity Total capital Shares $10 Revenue Less costs/ expenses EB...
HELP ME PLEASE!
24. Consider the following leverage scenarios Leverage Scenarios (000s) #2 50% Debt #1 0% Debt #3 80% Debt Capital Debt Equity Total capital Shares $10 Revenue Less costs/ expenses EBIT Interest expense (10%) EBT Taxes @ 40% Earnings after tax ROE EPS $1,600 400 $1,000 1,000 $2,000 $2,000 1,800 200 $2,000 1,800 200 100 100 40 $2,000 1,800 200 160 200 80 16 6% 6% 6% If under certain circumstances, financial leverage enhances performance measured by ROE...
Explain how debt financing (financial leverage) could improve the value of the firm. Explain why too...
Explain how debt financing (financial leverage) could improve the value of the firm. Explain why too much financial leverage might hurt the value of the firm.
32.Use of Financial Leverage by Private Equity Funds Explain why private equity funds use a very...
32.Use of Financial Leverage by Private Equity Funds Explain why private equity funds use a very high degree of financial leverage and how this affects their risk and potential return on investment.
In a perfect capital market, leverage will increase the cost of levered equity only if the...
In a perfect capital market, leverage will increase the cost of levered equity only if the debt is not risk free True or false
your friend makes the following argument: if there are no transaction costs, taxes or information asymmetry, as we increase the leverage of the firm, the risk of equity will increase. Consequently, stock holders will require a higher rate of return. the f
your friend makes the following argument: if there are no transaction costs, taxes or information asymmetry, as we increase the leverage of the firm, the risk of equity will increase. Consequently, stock holders will require a higher rate of return. the firm's debt will also become riskier and so bondholders will require a higher rate of return. Hence the firm's weighted average cost of capital will increase. is his statement true or false?
Suppose Levered Bank is funded with 1.6 % equity and 98.4 % debt. Its current market...
Suppose Levered Bank is funded with 1.6 % equity and 98.4 % debt. Its current market capitalization is $9.72 billion, and its market-to-book ratio is 1.1. Levered Bank earns a 4.23 % expected return on its assets (the loans it makes), and pays 3.6 % on its debt. New capital requirements will necessitate that Levered Bank increase its equity to 3.2 % of its capital structure. It will issue new equity and use the funds to retire existing debt. The...
Companies that use debt in their capital structure are said to be using financial leverage. Using...
Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Water and Power Co. is a small company and is considering a project that will require $650,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 25%. What will be the ROE (return on equity) for this project...
Companies that use debt in their capital structure are said to be using financial leverage. Using...
Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Western Gas & Electric Co. is a small company and is considering a project that will require $500,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 25%. What will be the ROE (return on equity) for this...
1. Explain why the costs of debt and equity are expected to increase as leverage increase? (Note: We didn't cover this directly in class, but we talked about this indirectly. Hint: It has to do with risk) 2. If the Debt-to-Asset ratio is .46, what is the Debt-to-Equity ratio? 3. Suppose a farm business indicates an average cost of farm debt of 12%, a rate-of-return on farm assets of 15%, and a debt-to-equity ratio of 1.0. What is the firm's...
When both debt and equity become riskier due to an increase in the firm's leverage, the firm remains worth exactly the same and stays exactly as risky (in a perfect market) Conceptually, what would it take for the firm to become worth more and/or safer even when both debt and equity become riskier due to an increase in the firm's leverage? Q 16.29
HELP ME PLEASE!
24. Consider the following leverage scenarios Leverage Scenarios (000s) #2 50% Debt #1 0% Debt #3 80% Debt Capital Debt Equity Total capital Shares $10 Revenue Less costs/ expenses EBIT Interest expense (10%) EBT Taxes @ 40% Earnings after tax ROE EPS $1,600 400 $1,000 1,000 $2,000 $2,000 1,800 200 $2,000 1,800 200 100 100 40 $2,000 1,800 200 160 200 80 16 6% 6% 6% If under certain circumstances, financial leverage enhances performance measured by ROE...
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