This preview shows page 1. Sign up to view the full content.
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...
View Full Document