0
What does risk taking have to do with the use of operating and financial leverage?
Operating leverage---the use of fixed resources
Financial leverage---the use of debts
Both operating and financial leverage imply that the firm will employ a heavy component of fixed cost resources. This is inherently risky because the obligation to make payments remains regardless of the condition of the company or the economy.
What else can I help you with?
What are the importance of operating leverage?
help to judge risk in the firm
Indicate the relationship between financial leverage and financial risk?
As the financial leverage increases, the breakeven point of the company increases. The company now has to sell more of its product (or service) in order to break even. As the financial leverage increases, the risk to banks and other lenders increases because of the higher probability of bankruptcy. As the financial leverage increases, the risk to stockholders increases because greater losses may be incurred if the company goes bankrupt. As the financial leverage increases, the risk to stockholders increases because the higher leverage will cause greater volatility in earnings and greater volatility in the stock price.
Is the risk to the firm of being unable to cover operating costs?
Financial risk
Financial risk of running a business?
financail risk of operating and opening a business
What happens to the costs of debt and equity when leverage increases?
Key Points If value is added from financial leveraging then the associated risk will not have a negative effect.At an ideal level of financial leverage, a company's return on equity increases because the use of leverage increases stock volatility, increasing its level of risk which in turn increases returns.If earnings before interest and taxes are greater than the cost of financial leverage than the increased risk of leverage will be worthwhile. Terms solvency The state of having enough funds or liquid assets to pay all of one's debts; the state of being solvent. liquidity Availability of cash over short term: ability to service short-term debt.
Does the firm use financial leverage if preferred stock is present in its capital structure?
Yes, a firm can be considered to use financial leverage if preferred stock is part of its capital structure. Preferred stock is a form of equity that typically has fixed dividend payments, similar to debt obligations. While it does not create a legal obligation like debt does, the presence of preferred stock can still increase the firm's financial risk and amplify returns on common equity, characteristic of financial leverage. Therefore, the inclusion of preferred stock indicates some level of financial leverage.
A high degree of financial leverage means?
A high degree of financial leverage means the benefits from tax-deductibility of interest(from additional debt) is more than offset by the increase in financial distress. The firm's fixed obligations are higher and the risk of a likely default is increased with a higher Debt to Equity ratio. There isn't any set out formula that sets the optimal leverage for a firm...but at some some point taking on more debt, with increases the risk anf thus the return of Equity holders further increases the risk of bondholders and creditors to the firm. Any default in payments leads to distress including bankruptcy, more financial burdens to fight off or succomb to bankruptcy, lower value of firms residual assets allocated to Equityholders and likelihood of the firm shotting down.
What is meabt by operating leverage?
- It measures the EBIT's percentage change as a result of a change of one percent in the level of output. - It helps in measuring the business risk.
How to calculate the leverage ratio for a company?
To calculate the leverage ratio for a company, divide the company's total debt by its total equity. This ratio helps measure the company's level of financial risk and how much debt it is using to finance its operations.
The risk-free rate of return used to determine a firm's cost of capital will not vary depending upon the financial and operating risk level of the firm?
That is NOT true.
How can one determine the leverage ratio of a company or investment?
The leverage ratio of a company or investment can be determined by dividing the total debt by the total equity. This ratio helps assess the level of financial risk and the amount of debt used to finance operations.
Can all types of companies maintain a high financial leverage in their capital structure?
No Company is defined by rules which they WANT to operate. Companies have to be worthwhile for someone/thing to lend them money. What company makes money on does not matter much though, like food, computer, service,bank etc.
