If a firm must issue subordinated debentures instead of equipment trust certificates, the marginal cost of capital may rise even though the optimal capital structure is maintained.

Question

Quizplus · Accepted Answer

Subordinated debentures typically have a higher interest rate than equipment trust certificates due to their lower priority in the event of bankruptcy. Therefore, issuing subordinated debentures would increase the cost of debt for the firm and potentially increase the overall marginal cost of capital. However, if the optimal capital structure suggests a need for more debt financing, the firm may have no choice but to issue subordinated debentures despite the higher cost.

If a Firm Must Issue Subordinated Debentures Instead of Equipment