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Implications of a Change and risk.

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What are the implications of a change in the return on equity with an increase in debt financing?

What is the relationship between business risk, financial risk, and beta (systematic or market risk)?

How does the degree of operating and financial leverage change the profitability of the firm when sales levels change significantly. Use examples and explain your answers?

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Solution discusses relationship between business risk, financial risk, and beta (systematic or market risk)

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What are the implications of a change in the return on equity with an increase in debt financing?
- Increase in debt financing can lead to increase in return on equity to a certain extent. There can be reduction in return on equity at very high levels of debt financing because of very high financial risk.
Example: Suppose the return on equity is 12% and cost of debt financing is 8% untill debt equity ratio of 2:1. This will lead to increase in return on equity as cost of debt is less than return on equity. But if cost of debt increases to 13% beyond 2:1 debt equity ratio then the Return on equity will decline.

What is the relationship between business risk, financial risk, and beta (systematic or market ...

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