When a firm uses debt in its capital structure, it is referred to as a leveraged firm
and this concept is referred to as financial leverage. Operating leverage refers to a
firm’s fixed costs of production. The higher the fixed costs, the greater the degree
of operating leverage that is being employed. How does the degree of operating
and financial leverage affect the beta of a firm? For a firm just beginning
operations, what recommendations would you make about the use of debt in the
capital structure? How would these recommendations affect the company’s beta
coefficient and the investors’ required rate of return? Would your
recommendations change if the firm were a long-established operation? Why or
why not?
