FIN 322 Study Guide - Final Guide: Operating Leverage, Capital Structure, Standard Deviation
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Which of the following statements is most correct?
| If a firm is exposed to a high degree of business risk as a result of its high operating leverage, then it probably should offset this risk by using a larger-than-average amount of financial leverage. This follows because debt has a lower after-tax cost than equity. | ||
| Financial risk can be reduced by replacing common equity with preferred stock. | ||
| The Hamada equation specifies the effect of financial leverage on beta. It shows how increases in the debt/equity ratio lowers beta. | ||
| In the textbook, it was stated that the capital structure that minimizes the WACC also maximizes the firmâs stock price and its total value, but generally not its expected EPS. One reason given for why debt is beneficial is that it shelters operating income from taxes, while it was stated that a disadvantage of excessive debt has to do with costs associated with bankruptcy and financial distress generally. | ||
| All of the above statements are false. |
