1. Which statement is most true a. Adding debt makes ROE numbers lower but lowers the...

1. Which statement is most true

a. Adding debt makes ROE numbers lower but lowers the WACC

b. Adding debt can increase EPS but may increase the WACC as more debt is added

c. Adding debt can increase the ROE and will always result in the highest stock price and lowest WACC

2. The new firm wants to minimize fixed costs. What does this mean?

a. This will keep operating leverage down which in turn will lower business risk

b. This will lower financial risk which in turn lowers the risk of the firm.

c. Higher fixed costs will leverage up returns and lower business risk

d. Higher operating leverage is directly associated with higher financial risk.

Expert Solution

1 A

Adding debt will reduce ROE since the interest payments will reduce the income available to equity shareholders. It will decrease the WACC since debt has a lower cost due to tax shield on interest payments. Hence other options are incorrect.

2A

Lesser fixed costs will reduce the operating leverage which will reduce the business risk caused by volatility in sales due to cost structure. It will not impact financial risk which is caused due to teh capital structure and not cost structure. It cannot leverage up the returns since higher costs will reduce the returns.

jeff jeffy answered 2 years ago

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