CHAPTER 17

9aasthedebtequityratioincreasesboththecostofdebtcapita

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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.

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