If an investor buys a portion (X)of the equity of a levered firm, then his/her payoff is
A)(X)× (profits).
B)(X)× (interest).
C)(X)× (profits − interest).
D)(1/X)× (profits − interest).

Question

Quizplus · Accepted Answer

The investor's payoff is based on their portion (X) of the equity of the levered firm. Therefore, the investor's share of profits would be (X)× (profits), but they would also have to account for the interest payments owed to debt holders, which would reduce their share of profits. Therefore, the most accurate representation of the investor's payoff would be (X)× (profits − interest), which is answer choice C.

If an Investor Buys a Portion (X)of the Equity of a Levered