The decline in earnings per share beyond that ratio

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Unformatted text preview: isk increases with increasing leverage. A portion of the risk can be attributed to business risk, but the portion that changes in response to increasing financial leverage would be attributed to financial risk. Clearly, a risk–return tradeoff exists relative to the use of financial leverage. How to combine these risk–return factors into a valuation framework will be addressed later in the chapter. The key point to recognize here is that as a firm introduces more leverage into its capital structure, it will experience increases in both the expected level of return and the associated risk. Agency Costs Imposed by Lenders As noted in Chapter 1, the managers of firms typically act as agents of the owners (stockholders). The owners give the managers the authority to manage the firm for the owners’ benefit. The agency problem created by this relationship extends not only to the relationship between owners and managers but also to the relationship between owners and lenders. When a lender provides funds to a firm, the inte...
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This document was uploaded on 01/19/2014.

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