Capital Structure and Risk of Using Debt This issue has three parts. On December 2, 2001, the highfl

Capital Structure and Risk of Using Debt This issue has three parts. On December 2, 2001, the highfl

Capital
Structure and Risk of Using Debt

This issue has three parts.

On December 2, 2001, the
highflying energy firm, Enron, filed for bankruptcy. This is the largest
bankruptcy in U.S. history. While the factors that led to the fall of Enron are
clearly not limited to use of large amounts of debt in the capital structure,
the use of financial leverage was a major factor leading to its demise. Thelead
story in BusinessWeek’s December 17, 2001, issue covered the fall of Enron
(see.businessweek.com/magazine/content/01_51/b3762001.htm”>http://www.businessweek.com/magazine/content/01_51/b3762001.htm). After reading the article, answer the following
questions:

1. Describe the relative amount
of debt that Enron carried directly versus indirectly through off-balance sheet
financing.

2. The company almost avoided
bankruptcy through a buyout by the firm, Dynegy, but that failed. What did Dynegy
discover when it was evaluating the merger proposal?

3.
What international factors also contributed to the failure of Enron?

Capital Structure Decision

How do companies decide on
their capital structures? Do many publicly-traded companies have preferred
stocks in their capital structures?

Business versus Financial Risk:

Explain
what is meant by business and financial risk. Suppose firm A has greater
business risk than firm B. Is it true that firm A also has a higher cost
of capital? explain.

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