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Unformatted text preview: erred equity redemption cumulative stock and floatingrate notes. Note that, in order
to succeed, such securities must both meet regulatory requirements and appeal to an
unsatisfied clientele. 8. Why does share price drop during a recession? Because forecasted cash flows to
stockholders decline. (Stockholders may also perceive higher risks and demand a higher
expected rate of return.) The stock price will decline to the point where the expected
return to the stock, given the amount of debt, is a ‘fair’ return. Suppose that a recession hits and stock price declines. Would the cost of capital for new
investment be less if the firm had used more debt in the past? No, the firm’s past
financing decisions are bygones. Moreover, MM’s Proposition I holds in recessions as
well as booms. The firm’s overall cost of capital is independent of its debt ratio. Incidentally, the more debt a firm has, the greater the percentage decline in the value of its
shares as a result of a recession or any othe...
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This note was uploaded on 04/26/2013 for the course MATH 289Q taught by Professor Jamesbridgeman during the Fall '04 term at UConn.
- Fall '04