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Unformatted text preview: ional lenders will not advance 100 percent of the asset’s value for an 8 percent promised return unless other assets are put up as collateral. Sometimes firms find it convenient to borrow all the cash required for a particular investment. Such investments do not support all of the additional debt; lenders are protected by the firm’s other assets too. In any case, if firm value is independent of leverage, then any asset’s contribution to firm value must be independent of how it is financed. Note also that the statement ignores the effect on the stockholders of an increase in financial leverage. b. This is not an important reason for conservative debt levels. So long as MM’s Proposition I holds, the company’s overall cost of capital is unchanged despite increasing interest rates paid as the firm borrows more. (However, the increasing interest rates may signal an increasing probability of financial distress—and that can be important. 7. Examples of such securities are given in the text and include unbundled stock units, pref...
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