All else equal, which of the following activities should increase the financial risk of a firm?...

All else equal, which of the following activities should increase the financial risk of a firm?

Decrease common stock dividends
Issue new bonds
Issue new common stock
Repurchase (pay off) outstanding debt
An increase in the fixed operating costs

Solutions

Expert Solution

(b) is the correct option. Issuing new bonds increases the financial leverage, interest burden, and the risk of financial distress. Therefore it increases financial risk.

(a) is incorrect. Decreasing dividends leaves more cash in the firm's hands, and thus reduces financial risk.

(c) is incorrect. Issuing new common stock increases the equity base and decreases financial leverage, thus reducing the risk of financial distress. Therefore it decreases financial risk.

(d) is incorrect. Paying off existing debt decreases the financial leverage, interest burden, and the risk of financial distress. Therefore it decreases financial risk.

(e) is incorrect. This increases operating risk, not financial risk

jeff jeffy answered 2 years ago

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