valuable firm will tend to: A. see its stock price increase if it issues debt beyond...

valuable firm will tend to:

A. see its stock price increase if it issues debt beyond its optimal debt level.

B. issue more debt than a less valuable firm of comparable size.

C. reduce its debt level as a positive signal for the firm.

D. issue debt, but only on a temporary basis purely to fool investors regarding the firm's value.

E. see its stock price increase when it announces an exchange offer that decreases its leverage.

Expert Solution

It is a common misconception that a firm with less debt level is valuable and stronger than firm with more debt. To be precise, firms should neither issue low levels debt nor the high levels debt .If the firm is using low levels of debt, then we can say that it is not using the leverage completely to grow the business and if the firm using high levels of debt then we can say that it is overleveraged and may incurr higher interest cost which may also leads to bankruptcy some times.So there is some optimal level of leverage where the firms can benefit at most.

So, if there are two firms of comparable size, the firm which is able issue more debt is more valuable than firm which is not. Because, it is able to issue more debt due to the confidence the debt holders having on the firm's capacity of repayment and its ability to use the funds properly to generate good earnings.

Ans: B) Issue more debt than a less valuable firm of comparable size

jeff jeffy answered 2 years ago

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