Identify issues relevant to a corporation's funding choice between debt and equity.

A corporation must determine how it plans to finance its investment decisions.

A business must consider its current debt-to-equity ratio and the associated degree of financial risk. If the ratio is such that increased debt can be sustained without an undue increase in financial risk, it is in the interests of the shareholders for the expansion to be funded through debt rather than equity.

However, debt commitments (interest and principal) must be paid when due. Therefore, a corporation must forecast the business environment in which it operates and the impact of changes on future cash flows.

Once a business reaches an appropriate debt-to-equity ratio, further expansion requires additional equity

Question:

1. Explain the effect on the firm's market value of an increase in the firm's debttoequity ratio
2. Compare and contrast the average debttoequity ratios of commercial banks and major retailers, such as Woolworths. Why is there such a big difference?

Answer rating: 100% (QA)

The effect on the firms market value of an increase in the firms debttoequity ratio 1 Increase in Financial Risk As a firm increases its debttoequity ratio it becomes more leveraged which increases it... View the full answer