Question

Q-1: Suppose you are called for an internship position in finance at a reputed company Before appearing for the interview, the finance director of the company has asked you to do some research on the use of financial leverage in two different industriesone telecommunication and other tourism. What factors would you highlight to the finance director that may cause a difference in the use of financial leverage for these two different industries? What are the general limitations of the excess use of financial leverage?

Answer 1

Differences in the employment of the debt capital are as follows :

No	Differences in the Debt structure
1	· Tourism is mainly a Cyclical industry where the demand and the sales rises only in the peak seasons . while · Telecom belongs to the defensive industry as the demand for communication remains constant through the year .
2	· As such there would be difference in the type of debt capital to be employed in each of these sectors . · While the debt issued in the telecom sector may have an monthly payment of interest for the bank or Coupon payment for the bond holders from whom the debt capital is raised . · For tourism Industry , Only single year end payment can be considered after consolidation of the yearly Profit and loss and the Income statement .

Drawbacks of excessive financial leverage

· High use of financial leverage causes excessive Interest Burden on the company

· The amount of debt employed if high , the interest and coupon payments to the investors over exposes the cash flows of the company during uncertain times

· The business risk goes higher

· Failure to meet the debt obligations may lead to the liquidation of the firm

Thanks .