Respond to the required questions, double-spaced, APA format (source citations and reference insertions) essay (Each Question). In each Case Study, you must use at least three (3) references (in text), including the textbook (included below).
Textbook reference:
Berk, J. & DeMarzo, P. (2017). Corporate Finance: The Core (Fourth Edition). Boston, MA: Pearson.
(This Assignment Box maybe linked to Turnitin.)
Respond to the required questions, double-spaced, APA format (source citations and reference insertions) essay (Each Question). In each Case Study, you must use at least three (3) references (in text), including the textbook (included below). Textbook reference: Berk, J. & DeMarzo, P. (2017). Corporate Finance: The Core (Fourth Edition). Boston, MA: Pearson. (This Assignment Box maybe linked to Turnitin.) 150 Words: Discussion This discussion question has two parts. Use Figure 15.7 in your textbook which shows the net debt-to-enterprise value ratio for some select industries to answer both parts of the question. Respond to both parts to receive full credit for this assignment. Part 1: Firms in the real estate investment trusts (REITs), airlines, electric utilities, and paper products industries tend to have high leverage. Explain why firms in these industries would prefer to have high leverage. Part 2: Firms in the computer hardware, footwear, apparel and luxury goods, and data processing industries tend to have low leverage. Explain why firms in these industries would prefer to have low leverage. Include some news from an article that is less than a year old that is applicable to this discussion. 100 Words (Melissa Strickland) – Reply and Comment on the following: Financial leverage is used to describe a company’s reliance on debt in relation to total capital. REITs, airlines, electric utilities, and paper products industries tend to use large levels of debt to generate earnings. REITs are investments in real estate that can pay out 90% of its profits as dividends. According to Prosser (2017), “[mortgage] REITs are typically leveraged as high as 5-to-1.” The high leverage in the real estate industry largely is due to the significant upfront costs to construct or renovate new real estate. In a stable economy, REITs can generate large earnings for investors; however, in an economic downturn, Putzier (2020) states, “the shares of many of these [REITs] are trading at just 30% to 40$ of the net book value of their holdings.” These high leverage trusts may be risky, but clearly offer high payouts in dividends when successful in return for the risk. Airlines can experience downturns in the economy that cause demand to waiver; however, airlines exist in a relatively closed market. New airlines would find difficulty emerging into this market due to the large amount of debt that it would take to operate and compete with the well-established companies. Due to a lack of new competition, airlines are more willing to take on debt to compete with other established airlines in order to remain in the market successfully. Electric utilities and paper products industries have a stable and high demand. For these industries, they are less concerned about losses as they produce commodities that are needed. These companies can take on large amounts of debt knowing that demand is stable to repay loans as they become due. Computer hardware, footwear, apparel and luxury goods, and data processing industries tend to be funded more by equity than debt, which creates a lower leverage ratio. These industries can be significantly affected by changes in demand. Any technological product is subject to obsolescence due to continuous innovation. According to Hoyle (2019), “investment in cloud infrastructure has surged since 2015, and the market for data-center equipment is expected to grow at an average annualized rate of roughly 16% this year and next.” These large investments allow companies to develop improved products at a faster rate. Hoyle (2019) states, “cloud servers, though, typically have a lifespan of only about three years, according to experts, meaning that some of the earliest equipment already has passed its use-by date.” The demand in these technological products shifts with innovation, which can significantly affect demand if the firm does not stay at the forefront of advancement. Similarly, footwear and apparel and luxury goods experience changes in demand due to customer preferences. For example, many fashion designers come out with a new fall or spring collection every year. This demonstrates the changes in consumer tastes. If these companies financed operations through debt rather than equity, the numerous shifts in demand may cause them to default on loans as they become due. Ultimately, stable demand allows companies to successfully operate with higher leverage whereas constant shifts in demand require companies to operate with lower leverage in order to stay competitive in their industries. 100 Words (Nathan Blouse) – Reply and Comment on the following: Leverage is simply borrowed capital for an investment or project and utilizing leverage is very common with investors within various industries (Fomichenko, 2020). For anyone that has taken a mortgage to purchase a property has more than likely used leverage when investing in the property. Various mortgage types are available but most require a percentage of the purchase price to be provided by the purchaser. By taking out a mortgage for the remainder of the price, and the property appreciating in value, over time, leverages the mortgage to have higher appreciation returns. In order for an organization to be highly leveraged means that the organization has taken on too much debt relative to cash and equity which in turn makes them sensitive to economic declines and puts them at a higher risk for bankruptcy. For certain industries this is the normal way of business on a day to day basis and that includes real estate investment trusts (REITs), airlines, utilities, and other businesses. Companies that operate in this way financially are able to do so because they are established companies experiencing growth but are not dependent upon raising capital with investors to keep operations intact. While it makes the susceptible to the fluctuations in the economy, it provides them the liberty to make decisions without third-party influence. Companies that operate financially with low leverage means that they are not taking on debt to finance assets. These industries that operate in this way include pharmaceutical, software, and biotech companies (Berk & DeMarzo, 2017). These companies are dependent upon investors to raise capital in order to initially get operations up and running. Once established, these organization are likely to have to change the focus of their production in order to meet the changing demands of consumers. While this protects the organization from changes in the economy, it also empowers third-party investors to have influence on the direction of the organization. These organizations typically operate with more capital on-hand and not having it consumed by investments giving them more liquidity.