If a firm increases its financial risk by selling a large bond issue that increases its...

If a firm increases its financial risk by selling a large bond issue that increases its financial leverage explain this assumption?

Solutions

Expert Solution

Financial leverage is given through the following formula

DFL = EBIT / EBT

It essentially measures the firms earnings to pay off its interest cost. If the firm sells a large bond issue the risk is higher since interest payments are fixed and cannot be deferred. The firm must make sufficient money to pay the interest and if it does not make enough also it must service the debt. Hence, the financial risk increases through a large bond issue as the interest cost is also on the higher side.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

A 10-year bond of a firm in financial distress has a coupon rate of 12% and is selling at $900 (face value is $1,000). The firm is re-negotiating its debt and

A 10-year bond of a firm in financial distress has a coupon rate of 12% and is selling at $900 (face value is $1,000). The firm is re-negotiating its debt and the bond-holders have agreed to cut coupon payments in half.a. What is the stated (promised) yield-to-maturity on the bond? (i.e. what is the YTM at which the bond was trading?)b. How does it compare to the expected yield on the bond? (i.e. what is the expected yield given the...

In a firm commitment procedure, the majority of risk of the issue is borne by A....

In a firm commitment procedure, the majority of risk of the issue is borne by A. Designated Market Maker B. Issuing Firm C. Underwriter Syndicate D. Credit rating agencies

How does high business risk affect firm risk? Higher business risk increases the volatility of capital...

How does high business risk affect firm risk? Higher business risk increases the volatility of capital structure. Higher business risk increases the volatility of EBIT. Higher business risk increases the volatility of financial costs. Higher business risk increases the volatility of the firm's asset structure.

How does high business risk affect firm risk? Higher business risk increases the volatility of capital...

Up and Coming Yoga has an outstanding bond issue that is currently selling for $945.55 The...

Up and Coming Yoga has an outstanding bond issue that is currently selling for $945.55 The bond pays a semi-annual coupon at an annual rate of 8.55% and matures in 19 years. Using approximate formulas, what is the modified duration and convexity of this bond? Using duration and convexity measures you computed, calculate the change in price of this bond if the yield goes up by 30 basis points.

GE has an outstanding bond issue that is currently selling for $110.21 to yield 6.59%. The...

GE has an outstanding bond issue that is currently selling for $110.21 to yield 6.59%. The bond pays a semi-annual coupon of 8% and will mature in 10 years. Find the convexity of this bond using the approximate convexity formula. (You may use 10 basis point change in yield to approximate the convexity).

This was a financial innovation that has allowed banks to reduce risk in the issue of long term mortgage loans by repacking the loans and selling them as securities.

This was a financial innovation that has allowed banks to reduce risk in the issue of long term mortgage loans by repacking the loans and selling them as securities.Diversification.Short sellingMortgage Backed SecuritiesARM loans.

Explain why increasing financial leverage increases the risk borne by shareholders.

What is the before-tax cost of debt for Timberton's new bond issue selling for $850? The...

What is the before-tax cost of debt for Timberton's new bond issue selling for $850? The bonds mature in 20 years, pay annual interest on face value of $1,000 and the coupon rate is 8%, Question 28 options: 12.35% 7.83% 10.47% 9.73%

Campbell, Inc., has a $1,000 face value convertible bond issue that is currently selling in the...

Campbell, Inc., has a $1,000 face value convertible bond issue that is currently selling in the market for $990. Each bond is exchangeable at any time for 24 shares of the company’s stock. The convertible bond has a 6.9 percent coupon, payable semiannually. Similar nonconvertible bonds are priced to yield 9 percent. The bond matures in 10 years. Stock in the company sells for $40 per share. a-1. What is the conversion ratio? a-2. What is the conversion price?...

Subjects