Question

You expect your company to experience a sharp decline in revenue next year. Is your company more likely to survive if it is (a) highly leveraged or (b) not highly leveraged? Why?

Answer 1

Probability on survival of the company if

1. Company is Highly leveraged—When a company is highly leveraged then it has high liability on interest or in other words fixed cost of obligation which may affect the survival of the company if revenue decreases in the next year. This is because the amount of interest does not decrease with decrease In revenue as it remains the same. High cost of debt may adversely affect survival of a company with high leverage.
2. Not Highly leveraged Company is probably in a better position than a highly leveraged company in case when it is expected that revenue will decrease. Not highly leveraged company does not have high fixed interest cost and profits are distributed to common stockholders. If revenue decreases then dividend will decrease but company will still survive because dividend is not a fixed cost.