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Assignment 1 ARM

Leverage can impact a firm's investment decisions. The document discusses how debt financing is a cheaper source of capital for firms compared to equity, as interest payments are tax deductible. However, taking on too much debt poses bankruptcy risks. Studies have shown that highly leveraged firms' investments are more sensitive to cash flow and earnings compared to firms with low leverage, as high debt limits their financial flexibility for investments.

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Mirza Junaid
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39 views1 page

Assignment 1 ARM

Leverage can impact a firm's investment decisions. The document discusses how debt financing is a cheaper source of capital for firms compared to equity, as interest payments are tax deductible. However, taking on too much debt poses bankruptcy risks. Studies have shown that highly leveraged firms' investments are more sensitive to cash flow and earnings compared to firms with low leverage, as high debt limits their financial flexibility for investments.

Uploaded by

Mirza Junaid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Topic: Impact of Leverage on Firm`s Investment Decision

Investment is a crucial economic activity in the corporate financial management. Such an


Activity leads to the countrys economic development provide employment to the people
And to eliminate poverty. I will investigate the effect of debt financing on the firms investment
decision on pharmaceutical industry in Pakistan. It plays a significant role in the countrys
economic and industrial development and trade and to prevent diseases for increasing the life of
people. This industry is providing a basic material to other industrial sectors. It requires capital
for financing firms assets. Among the different sources of fund, debt is a cheaper source because
of its lowest cost of capital. The investment decision of the firm is of three categories that can be
adopted by firms management besides the financing decision and the net profit allocation
decision (J.franklin, 2011)
As far as the hierarchy of financing sources as it exists in the economic literature, is concerned,
cash flow is the cheapest financing sources followed by debts and in the end, by its issuing of
new shares. The debt limit of the firms is determined in the view, since interest payment is tax
deductible, the firm prefers debt financing to equity and it would rather have an infinite amount
of debt, However, this leads to negative equity value in some status so that the firm would rather
go bankrupt instead of paying its debt. Therefore debt to remain risk-free, lenders will limit the
amount of debt. one of the main issues in corporate finance is whether financial leverage has any
effects on investments policies.
Whited (1992) has shown how investment is more sensitive to cash flow in firms with high
leverages as compared to firms with low leverage. Cantor (1990) showed that investment is more
sensitive to earnings for highly levered firms

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