A policy of maximizing the value of the firm is the same as a policy of maximizing the shareholders' wealth rests on two important assumptions. They are:
I. the firm can ignore dividend policy
II. the debt equity ratio of the firm does not change
III. an issue of new debt does not affect the market value of existing debt
A) I only
B) II only
C) III only
D) I and III only

Question

Quizplus · Accepted Answer

Assumption I is important because if the firm can ignore dividend policy, it can retain earnings and reinvest them in projects that have positive net present value, which will increase the value of the firm and ultimately benefit shareholders.

Assumption III is important because if an issue of new debt does not affect the market value of existing debt, it means that the cost of debt is constant, which allows the firm to maintain its debt-equity ratio and reduce the cost of capital. If the cost of capital is lower, then the value of the firm will be higher, which will benefit shareholders.

A Policy of Maximizing the Value of the Firm Is