True or False : In general, the more business risk that a firm experienes, the m

Question

True or False: In general, the more business risk that a firm experienes, the more financial leverage the firm will want to employ in its capital structure.

True or False: When its earnings are decreasing, the use of greater levels of debt capital in a firms capital structure magnifies the negative return earned by the firms shareholders beyond that earned by the shareholders of an otherwise identical unleveraged firm.

True or False: The pretax cost of debt increases as the firms risk of bankruptcy increases.

True or False: An increase in the risk of bankruptcy is likely to reduce the firms free cash flows in the future.

True or False: An increase in debt financing decreases the risk of bankruptcy.

Explanation / Answer

1) True - Business risk generally is due to Financial laverage and not because of operating laverage.

2) True - When the companies EBITDA margins are lower or marginally higher than the cost of debt when the company is financially levegared, the statement holds true.

3) True - as the credit risk increases, the cost of borrowing would also increase.

4) True - This can be linked to inability of the firm to borrow and operate at a sustainable rate.

5) False - Bankruptcy can arise only because of debt.

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