If an investor buys "a" proportion of the equity of a levered firm (firm L) then his/her payoff is:
A) (a) * (profits)
B) (a) * (interest)
C) (a) * (profits - interest)
D) none of the above

Question

Quizplus · Accepted Answer

A levered firm has debt obligations (interest) that must be paid before profits are distributed to equity holders. Therefore, an investor's payoff would be proportionate to the profits earned by the firm minus the interest payments on its debt. Hence, option C is the correct choice.

If an Investor Buys "A" Proportion of the Equity of a Levered