Effect on return on equity of raising capital through debt

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Reference no: EM13751897

Debt has deadlines. Deadlines can be missed. Common stock lasts indefinitely. The higher percentage of resources raised from debt, the higher percentage resources subject to deadlines, hence risk.

Required:

a. What is the effect on return on equity of raising capital through debt? There would appear to be two effects: the cost of debt and the amount of debt. To respond to this question you will need to explain the relationship, ROCE = ROA x Common Earnings Leverage x Financial Structure Leverage. Explain the numerator and denominator for the ratios and how they capture the cost of debt and the amount of debt.

b. Having extended a loan to a company, a banker uses accounting reports to evaluate compliance with the terms of the loan. Give an example of a term where accounting might play a role.

Reference no: EM13751897

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