Assume that the risk-free interest rate in the United States is the same as that in Country M. Assume that the government of Country M is more likely to rescue local firms that experience financial problems. Other things being equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country M has the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital will likely be ____ than that of the U.S. firm.
A) higher; higher
B) higher; lower
C) lower; lower
D) lower; higher

Question

Assume that the risk-free interest rate in the United States is the same as that in Country M. Assume that the government of Country M is more likely to rescue local firms that experience financial problems. Other things being equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country M has the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital will likely be ____ than that of the U.S. firm.​
A) ​higher; higher
B) ​higher; lower
C) ​lower; lower
D) ​lower; higher

Quizplus · Accepted Answer

The government's likelihood to rescue firms in Country M reduces the perceived risk of investing in those firms, encouraging them to use a higher degree of financial leverage due to the safety net. This safety net also likely reduces their cost of capital compared to U.S. firms, as investors demand less risk premium.

Assume That the Risk-Free Interest Rate in the United States