Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:

Question

Quizplus · Accepted Answer

When firms are facing financial distress, they may not want to commit new equity to positive net present value (NPV) projects because the benefits of the project may be shared with their bondholders. In financial distress, the firm's bondholders may have a claim on the firm's assets and cash flows, and committing new equity to projects may reduce the amount of cash available for paying off bondholders. Therefore, the firm may pass up positive NPV projects to avoid worsening its financial distress.

Firms Facing Financial Distress May Pass Up Positive NPV Projects