Question

a. What role does risk play in the leverage choice?

b. When will increasing your financial leverage cause an increase in growth of equity?

c. True, False, Uncertain and Why? A farmer would want to try to minimize his taxes if he wants his equity to grow fast.

Answer 1

A. Risk plays an important role in leverage choice because risk related to leverage is higher in terms of insolvency of the business because leverage will be having a fixed repayment so higher amount of leverage will be leading to higher amount of risk and risk and leverage have a direct relationship.

B. Increasing the financial leverage can cause increase in the growth of equity when the company is having a very high rate of return on its investment than the cost of debt, So, when there would be a lower cost of debt than the Return of Investment, the additional benefit would be leading to increase the return on equity.

C. The given statement is TRUE as minimization of tax will lead to maximization of return on equity because equity are directly taxable and hence he will want lower tax.