Answer the following questions:

a) Explain what is meant by “business risk” and “financial risk”.

b) Assume that Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital? Explain.

c) Why is the use of debt financing referred to as using financial “leverage”? What is “homemade leverage”? Explain.

d) Describe the “trade-off” that defines the static theory of capital structure.

e) You are considering a firm under three separate scenarios: (1) no debt, no taxes, and no bankruptcy costs; (2) with debt and with taxes but no bankruptcy costs; and (3) with debt, with taxes, and with bankruptcy costs. Under which one of these three scenarios will the firm have the highest value? Explain your answer.

Answer rating: 100% (QA)

a Business risk refers to ability of the company to generate enough revenues to cover its operationa... View the full answer