fm16 2 - markets. Public utilities have lower retained...

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Answers and Solutions: 16 - 2 16-5 If sales tend to fluctuate widely, then cash flows and the ability to service fixed charges will also vary. Such a firm is said to have high business risk. Consequently, there is a relatively large risk that the firm will be unable to meet its fixed charges, and interest payments are fixed charges. As a result, firms in unstable industries tend to use less debt than those whose sales are subject to only moderate fluctuations. 16-6 Public utilities place greater emphasis on long-term debt because they have more stable sales and profits as well as more fixed assets. Also, utilities have fixed assets which can be pledged as collateral. Further, trade firms use retained earnings to a greater extent, probably because these firms are generally smaller and, hence, have less access to capital
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Unformatted text preview: markets. Public utilities have lower retained earnings because they have high dividend payout ratios and a set of stockholders who want dividends. 16-7 EBIT depends on sales and operating costs. Interest is deducted from EBIT. At high debt levels, firms lose business, employees worry, and operations are not continuous because of financing difficulties. Thus, financial leverage can influence sales and costs, and hence EBIT, if excessive leverage is used. 16-8 The tax benefits from debt increase linearly, which causes a continuous increase in the firms value and stock price. However, financial distress costs get higher and higher as more and more debt is employed, and these costs eventually offset and begin to outweigh the benefits of debt....
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