1. According to signaling theory, under what circumstances would a company issue stock instead of debt?...

1. According to signaling theory, under what circumstances would a company issue stock instead of debt? Explain why.

2. What is an unlevered beta?

Solutions

Expert Solution

1. Signal theory suggests that any information or signal about a company can determine the rise or fall of stock price.Dividend payout information , information about IPO of a company, new acquisitions of a company are signals or indicators about the future performance or stock price of a company.

As per signalling theory retained earnings should be used first, the debt and equity to meet capital expenditure. However if the company is over leveraged and the incremental cost of debt increases the the company should issue stock .To reduce the risk in the company stock issue could be used to retire certain portion of debt to reduce risk and provide positive signal to the investors or market.

2. Beta is the covariance of the stock return with market divided by variance of market returns. Beta of a company when it would finance the company or project with only equity and no debt is unlevered beta. Beta levered is higher than beta unlevered.

Beta unlevered = Beta levered /(1+(1-Tax rate)* Debt/Equity)

jeff jeffy answered 7 months ago

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