Question

Your Chief Financial Officer (CFO) has asked your opinion about the use of financial leverage in two different industries; one telecommunication and other tourism. What factors would you highlight to your CFO 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

When there would be use of leverage in two different sectors specifically telecommunications and other tourism, I would be considering various factors and explaining it to the chief financial officer-

A.In the industry of tourism, there would be high cash realisation and there would be a higher liquidity on the hands of the company So, in such situations it is always advisable to use a high leverage because when there would be higher liquidity in the hands of the company then higher leverage would be helpful in growth and expansion of the company because the company will be able to pay with it's debt repayment schedule in the form of interest,so in such cases the company need to take high level of financial leverage.

B. In case of the telecommunication industry, company should be trying to take lesser financial leverage because telecommunication industry is more like a capital incentive industry and the cash realisations are always needed in the longer perspective and the Liquidity would be lower on the part of the company because realisations would be in a longer period of time and the debt repayment are involved with the shorter time, So the company will be dealing with financial crunch if it is going for the high leverage in telecommunication industry so I would not advertising use of financial leverage in telecommunication industry.

Problems which are associated with financial leverage is that, there is a fixed cost of repayment associated with financial leverage in the form of interest and it is it irrespective of whether the company is making profit or loss and there will always be a cost of financial risk associated with financial leverage and there will also be risk related with so the company must be discounting all these factors.