Question
In: Finance
As debtholders rank ahead of shareholders, it is expected that the required rate of return on...
As debtholders rank ahead of shareholders, it is expected that the required rate of return on debt will be higher than the required rate of return on shares. Discuss the validity of this statement.
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Expert Solution
Yes, it is true that debtholders rank ahead of shareholders in case the company goes bankrupt. This means before the shareholders are paid, the company first pays the debtholders, and then if anything is leftover then the shareholders are paid.
But, the required rate of return on debt will be lower than the required rate of return on shares. As stated above debtholders have a claim on the company's assets first before shareholders are paid. For this privilage, debtholders accept a lower rate of return.
And, shareholders expect a higher rate of return for taking on the additional risk as they are the last ones to be paid after the bondholders are paid.
So, to summarise, the cost of debt < the cost of equity
jeff jeffy answered 2 years agoRelated Solutions
As debtholders rank ahead of shareholders, it is expected that the required rate of return on...
As debtholders rank ahead of shareholders, it is expected that
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required rate of return on shares. Discuss the validity of this
statement.
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please a new and different answer. Thank you
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1. Explain the difference between the required rate of return and the expected rate of return....
1. Explain the difference between the required rate of return
and the expected rate of return. If they are different at a
specific point in time, what does it mean?
2. What is the difference between an expected return and a total
holding period return?
3. How does investing in more than one asset reduce risk through
diversification?
1. Explain the difference between required rate of return and expected rate of return. If they...
1. Explain the difference between required rate of return and
expected rate of return. If they are different at a specific point
in time, what does it mean?
2. What is the difference between an expected return and a
total holding period return?
3. How does investing in more than one asset reduce risk
through diversification?
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