Question

How does a firm “leverage” its capital structure? When is leverage

advantageous? When is it disadvantageous? Who receives the advantage or bears

the disadvantage of leverage? Describe how recent rule changes will require

leases to be accounted for beginning in 2019. How do the old lease accounting

rules differ from the new lease accounting rules? How do the new lease

accounting rules impact leverage?

Answer 1

a firms leverages it's capital structure, by introducing debt in it's capital structure.

advantages of leveraging:

1. levered firms generate higher shareholder profits, than the businesses that only rely on stock sales for financing.

2.using financial leverage can free a significant amount of cash for use in the long term. The business can then use the free cash for a number of purposes.

Disadvantages of leveraging :

1. the high interest rates that can come along with increased leverage in firm, can be a costky affair to the businesses. The higher earnings generated as a result of higher interest rates, also leads to higher dividend payments. The costs of the business builds up with the additional of debt in the capital structure.

2. the business with a newly found product , is a risky venture. The risky nature of business attracts higher rate of interests for the debt raiased by the business which can also lead the firm towards bankruptcy.

the firms who are already established and have a name, enjoys additional debt at lower costs and enjoys debt tax shield and higher cash flows. The firms which are new and risky, often face disadvantages of additional debt in the form of higher interest rates and risk of bankruptcy.

according to the changes in the accounting rules, the off balance sheet transactions will now be recorded ,so that the investors and the other users of financial statements can readily understand the rights and obligations associated with these transactions. It will increase the leverage in the balance sheet which the business would maintain off balnce sheet earlier will now be obligated to report these transactions to report thr true picture of the business all the associated asets and liabilities attached to a lease will now be reported on the balance sheet.