Question

describe how firms in different industries have different capital structures and how a firm’s capital structure, especially its financial leverage, is driven by the nature of the industry within which the firm operates

Answer 1

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part 1: financial leverage meaning.

financial leverage= EBIT/EBT

EBIT= earnings before interest and tax.

EBT= earnings before tax.

Factors which affect financial leverage are financial fixed costs.

For example: interest on bank loans, preference dividend, interest on debt etc.

Higher Financial leverage represents higher debt financing.

Higher debt financing is used to increase the equity return.

Part 2: Main Answer.

If a company is an asset-heavy Industry and it is investing heavily on the project then it should use debt financing because debt financing is the cheapest source of long term capital.

Example: if a utility company investing heavily on a power plant then it should be using debt financing for its growth in its capital structure.

If a company is an asset-light Industry like a software company (Tech company) or internet company then it can use equity for its growth.

A higher competitive business should use less debt for its growth.

Ex: Retail business should have more Equity.

A more stable Industry can have higher debt.

Example: Power generation.