Q1 a) If higher leverage is associated with greater risk, explain why the process of deleveraging (reducing...

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Finance

Q1
a) If higher leverage is associated with greater risk, explainwhy the process of deleveraging (reducing leverage) can bedestabilizing.
b)
You wish to buy an annuity that makes monthly payments for aslong as you live. Describe what happens to the purchase price ofthe annuity if:
(1) your age at the time of purchase goes up, (10 points)
(2) the size of the monthly payment rises, and (10 points)
(3) your health improves. (10 points)

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Q1 a Higher leverage is indeed associated with higher risk because it creates solvency issues Higher the leverage higher the solvency ratios which means the company does not enjoy investors confidence in the business and forgoes the benefits related to capital raised via equity which is reinvesting the profits back into the business without the burden of compulsory payments However having said that debt also brings with it certain benefits the first and the foremost being lower taxes taxes saved due to paying interest on debt and reducing the burden on weighted average cost of capital WACC WACC is a function of cost of Equity Ke plus cost of Debt Kd Now as we all know that debt is relatively cheaper as compared to capital because it entails fixed payments which is not the case with Equity Accordingly any instrument with fixed payments will naturally be less riskier as compared to instrument with no fixed payments like shares Raising debts helps in increasing return on Equity so in order to achieve an See Answer

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