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In: Accounting

What will be the effect of using the book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

What will be the effect of using the book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

A. The debt-to-value ratio will be overstated.

B. The debt-to-value ratio will be understated.

C. There will be no effect on WACC decisions.

D. It cannot be determined without knowing interest rates.

 

Solutions

Expert Solution

What will be the effect of using the book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

B. The debt-to-value ratio will be understated.

 

MV Equity = 5 million

MV Debt = 2 million

Value of firm = 7 million

D/V = 5/7 = 0.286.

 

if MV Debt = 2.5 million, then

MV of firm = 7.5 million

then DV = 2.5/7.5 = 0.333

B. The debt-to-value ratio will be understated.

Renze Joy Candido answered 3 years ago
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