Assignment #13 answers

Assignment #13 answers - Answers to Assignment No. 13...

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Answers to Assignment No. 13 Chapter 15- Questions and Problems: Answer to Q 1 a. True. b. False. As leverage increases, the expected rate of return on equity rises by just enough to compensate for its higher risk. The stock price and stockholders’ wealth are unaffected. c. False. The sensitivity of equity returns to business risk, and therefore the cost of equity, rises with leverage even without a change in the risk of financial distress. Answer to Q 2 While the costs of both debt and equity do increase, the weight applied to debt in the cost of capital formula also increases. Applying a higher weight to the lower-cost source of capital offsets the increase in the expected returns. Answer to Q 7 The pecking order theory states that firms prefer to raise funds through internal finance, and if external finance is required, that they prefer debt to equity issues. This preference – or pecking – order is due to the fact that investors may interpret security issues – equity issues in particular – as a signal that managers think the firm is currently overvalued by the market; therefore, investors will
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This document was uploaded on 03/07/2011.

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Assignment #13 answers - Answers to Assignment No. 13...

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