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Unformatted text preview: ts financial risk,
which is the risk to the firm of being unable to cover required financial obligations. The penalty for not meeting financial obligations is bankruptcy. The more
fixed-cost financing—debt (including financial leases) and preferred stock—a
firm has in its capital structure, the greater its financial leverage and risk. Finan- TABLE 12.9 Sales and Associated EBIT
Calculations for Cooke
Company ($000) Probability of sales
Sales revenue .25 .50 .25
$800 $400 $600 Less: Fixed operating costs 200 200 200 Less: Variable operating costs (50% of sales) 200 300 400 $0 $100 $200 Earnings before interest and taxes (EBIT) CHAPTER 12 Leverage and Capital Structure 527 cial risk depends on the capital structure decision made by the management, and
that decision is affected by the business risk the firm faces.
The total risk of a firm—business and financial risk combined—determines
its probability of bankruptcy. Financial risk, its relationship to business risk, and
their combined imp...
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