The more fixed cost financingdebt including financial

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Unformatted text preview: ts financial leverage and risk. Financial 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. 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 interest rate charged is based on the lender’s assessment of the firm’s risk. The lender–borrower relationship, therefore, depends on the lender’s expectations for the firm’s subsequent behavior. The borrowing rates are, in effect, locked in when the loans are negotiated. After obtaining a loan at a cert...
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This document was uploaded on 03/30/2014.

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