According to the signaling theory, when should a firm use debt beyond the normal target capital structure?
A) When the debt/assets ratio is greater than one
B) When marginal tax shelter benefits are equal to marginal bankruptcy-related costs
C) When investors and managers have identical information about the firm's prospects
D) When the firm has favorable prospects
E) When the firm is entirely equity financed

Question

Quizplus · Accepted Answer

According to the signaling theory, a firm should use debt beyond the normal target capital structure when it has favorable prospects. This is because taking on additional debt signals to investors that the firm is confident in its ability to repay the debt and has positive future prospects. This can lead to an increase in the firm's stock price and a reduction in the cost of capital.

According to the Signaling Theory, When Should a Firm Use