In your own words, explain what financial leverage is.

Explain why increasing financial leverage increases the risk borne by shareholders.

Explain why increasing financial leverage increases the return expected by shareholders.

In the opening line of Chapter 6 of the Higgins text (2012), Michael Sperry is quoted as saying "Equity Capital: The least amount of money owners can invest in a business and still obtain credit." What do you interpret this comment to mean?

CHAPTER The Financing Decision Equity Capital: The least an mount of money owners can invest in a business and still obtain credit. Michael Sperry In the last chapter, we our inquiry into finan a business cing looking at financial instruments and the markets in which they trade. In this chapter, we examine the company's choice of the proper finan cing Selecting the proper financing instruments is a two-step process. The first step is to decide how much external capital is required. Frequently this is the straightforward outcome of the forecasting and budgeting process described in Chapter 3. Management estimates sales growth, the need for new assets, and the money available internally. Any remaining monetary needs must be met from outside sources. Often, however, this is only the start of the exercise. Next comes a careful consideration of finan cial markets and the terms on which the company can raise capital. If management does not believe it can raise the required sums on agreeable terms, a modification of operating plans to bring them within budgetary nts is initiated. Once the amount of external capital to be raised has been determin the second step is to select-or, more accurately, instrument to be sold. This is the heart of the finan decision. As indicated in the cing last chapter, an issuer can choose from a tremendous vari ety of financial securities. The proper choice will provide the company with needed cash on attractive terms. An improper choice will result in excessive costs, undue ri or an inability to sell the securities. In this context, it is im portant to keep in mind that most operatin companies make money by vely acquiring and deploying assets, not by dreaming up clever ways creati to finance these assets. This means that the focus ofthe financing decision should general ly be on supporting the company's business and that care should be taken to avoid finan cing choices that carry even a modest chance of derailing this strategy. Better to make company financ- ing the passive handmaiden of operating strategy than to jeopardize that