A firm initially finances its assets with specified proportions of debt and equity, and then later issues additional debt, using the proceeds to pay a dividend to shareholders.If the new debt has the same priority as the original debt, the value of the original debt will probably fall, an effect called claim dilution.Which of the assumptions of an ideal capital market is violated in this example?
A)Capital Markets are frictionless
B)Homogeneous expectations
C)Atomistic competition
D)The firm has a fixed investment program
E)Once chosen, the firm's financing is fixed

Question

Quizplus · Accepted Answer

The assumption that is violated is that once chosen, the firm's financing is fixed. By issuing additional debt, the firm changes its capital structure, which affects the value of the original debt.

A Firm Initially Finances Its Assets with Specified Proportions of Debt