In: Finance
1. According to signaling theory, under what circumstances would a company issue stock instead of debt? Explain why.
2. What is an unlevered beta?
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)