12 Hour Deadline. 350 Words
Respond to the following questions:
- Why do public utility companies usually have capital structures that are different from those of retail firms?
- Why are earnings before interest and taxes (EBIT) generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?
Apa format
Answer:
Public Utility Companies vs. Retail Firms Capital Structures: Public utility companies usually have different capital structures from retail firms because of the nature of their businesses. Public utility companies provide essential services such as water, electricity, gas, and telecom services, which are regulated by government agencies. These companies often have lower risk tolerance and face stricter regulatory requirements, leading them to have lower levels of debt and higher levels of equity in their capital structures.
Earnings Before Interest and Taxes (EBIT) and Financial Leverage: Earnings Before Interest and Taxes (EBIT) is generally considered to be independent of financial leverage because EBIT represents a company’s operating profitability, independent of its financing decisions. However, when debt levels are high, financial leverage can influence EBIT in two ways. Firstly, interest expenses on debt increase as debt levels increase, reducing EBIT. Secondly, high debt levels can lead to reduced financial flexibility and increased risk, which may impact a company’s ability to invest and grow, leading to lower EBIT in the long term.
Reference:
- Fundamentals of Corporate Finance (Richard A. Brealey, Stewart C. Myers, and Franklin Allen)