FIN 300 Lecture Notes - Financial Risk, Ordinary Income, Capital Asset Pricing Model
Document Summary
Lo1 the effect of financial leverage on firm value and cost of capital. Lo2 the impact of taxes and bankruptcy on capital structure choice. Answers to concepts review and critical thinking questions. 8. (lo1) business risk is the equity risk arising from the nature of the firm"s operating activity, and is directly related to the systematic risk of the firm"s assets. Financial risk is the equity risk that is due entirely to the firm"s chosen capital structure. As financial leverage, or the use of debt financing, increases, so does financial risk and, hence, the overall risk of the equity. Thus, firm b could have a higher cost of equity if it uses greater leverage. (lo1) no, it doesn"t follow. While it is true that the equity and debt costs are rising, the key thing to remember is that the cost of debt is still less than the cost of equity.
