Answered: When comparing levered vs unlevered…

When comparing levered vs unlevered Capital structures why does leverage work to increase FPS for very high levels of earnings before interest and tax?

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter13: Valuation: Earnings-based Approach

Section: Chapter Questions

Problem 12QE

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Define the term capital intensity. Explain how a decline in capital intensity would affect the AFN, other things held constant. Would economies of scale combined with rapid growth affect capital intensity, other things held constant? Also, explain how changes in each of the following would affect AFN, holding other things constant: the growth rate, the amount of accounts payable, the profit margin, and the payout ratio.
Which of the following is most correct about the cost of capital? The cost of debt reflects the interest rates on debt capital before taking into account the tax effects. Cost of capital is affected by the required rates of return of each of the source of capital, regardless of the capital structure. The capital asset pricing model is the most widely used model to estimate the cost of common equity. To minimize the cost of capital, firms should borrow more than their capacity because increasing the lower cost of debt yields the lowest cost of capital, thus, enhances shareholder value.
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What is opportunity cost and why is it an important concept in the capital budgeting process? The opportunity cost concept applies to almost every financial decision we make as individuals. Can you give an example from your own experience? What is capital rationing from the perspective of capital budgeting? Give an example of a strength and a weakness of the accounting rate of return approach.
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