RWJ13

MKTG (with Marketing CourseMate with eBook Printed Access Card)

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Unformatted text preview: CHAPTER 13 LEVERAGE AND CAPITAL STRUCTURE Answers to Concepts Review and Critical Thinking Questions1. Business risk is the equity risk arising from the nature of the firm’s operating activity, and is directlyrelated to the systematic risk of the firm’s assets. Financial risk is the equity risk that is due entirely tothe firm’s chosen capital structure. As financial leverage, or the use of debt financing, increases, sodoes financial risk and hence the overall risk of the equity. Thus, Firm B could have a higher cost of equity if it uses greater leverage. 2. No, it doesn’t follow. While it is true that the equity and debt costs are rising, the key thing toremember is that the cost of debt is still less than the cost of equity. Since we are using more and moredebt, the WACC does not necessarily rise. 3. Because many relevant factors such as bankruptcy costs, tax asymmetries, and agency costs cannoteasily be identified or quantified, it’s practically impossible to determine the...
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