Respond to both APA and ref 200 words:
1. Berk and DeMarzo stated that the value of a firm with leverage exceeds the value of an unlevered firm. Additionally, there is a tax advantage to using debt financing (2017). High leverage in firms such as real estate investment trusts (REITs), airlines, electric utilities, and paper products is beneficial because if they can raise their market share then they can make a large amount of profit. The profit of the REIT is not taxed. A major part of the dividend may be deemed as a return of capital or as a gain of capital nature. This is subjected to a lower tax rate than normal interest and dividend income. Airlines use their high leverage to defeat the competition.
A firm receives a tax benefit only if it is paying taxes in the first place. The firm must have taxable earnings ((Berk&DeMarzo, 2017). The tax gain from leverage can take both positive and negative values. Negative values arise under a dividend relief tax system, when the personal tax rate on interest income is greater than the corporate tax rate, and the personal tax rate on dividend income is less than the corporate tax rate (Fan et al, 2012).
Firms in the computer hardware, footwear, apparel and luxury goods, and data processing industry tend to have low leverage. The main reason why management would prefer to have low leverage is that they prefer flexibility of cash flow over a lower cost of capital. Having high leverage is extremely risky. These companies may not be assured high profits, which doesn't allow them to take too much risk in larger debt. Another interesting fact is that Fan at al conducted experiments that indicated countries in which a firm resides is a more important determinant of how it is financed than is its industry affiliation, which in turn suggests that the differences in country-level institutional factors are likely to have a 1st-order effect on capital structure choices (2012).
2. 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.
Firms will have a higher leverage to increase profits. Debt is a cheaper source (but risker) of capital than equity. A reason that firms in certain industries are ok with higher leverage is due to the belief that product or service provided will always be needed (Titman, 2018). These firms believe their cash flows are relatively predictable and steady. The idea of taking on more debt is that you now have more funds (mostly borrowed) to use for investments or expansion to make more money than you ever would have with equity alone (Primera Group Inc., 2018). This would give some firms a fast edge over a competitor or take up new market share to expand your firm. However, effective financial leverage is still needed. With more debt there is now more risk. If sales are down or a firm does not manage its debt payments than higher leverage will be at serious risk of bankruptcy. Again, you might make more profits with borrowed money but if sales decline, expansion efforts fail then you risk losing profits while still owing money. Now you have a negative net position and risk bankruptcy.