Use the following information to answer the question(s)below.
Consider the following information regarding corporate bonds:
-If a firm's excess cash holdings are greater than its debt,using net debt as the measure of leverage will result in:
A)its unlevered beta and cost of capital equalling zero.
B)its unlevered beta and cost of capital being greater than its equity beta and cost of capital.
C)the risk of the firm's equity being increased by its cash holdings in excess of its operating needs.
D)the risk of the firm's debt being increased by its cash holdings in excess of its operating needs.

Question

Use the following information to answer the question(s)below.
Consider the following information regarding corporate bonds: 
-If a firm's excess cash holdings are greater than its debt,using net debt as the measure of leverage will result in:
A)its unlevered beta and cost of capital equalling zero. 
B)its unlevered beta and cost of capital being greater than its equity beta and cost of capital. 
C)the risk of the firm's equity being increased by its cash holdings in excess of its operating needs. 
D)the risk of the firm's debt being increased by its cash holdings in excess of its operating needs.

Quizplus · Accepted Answer

Using net debt (debt minus cash) to measure leverage will result in a lower leverage ratio when a firm's excess cash holdings are greater than its debt. This lower leverage implies a lower risk compared to using gross debt, leading to a lower unlevered beta and cost of capital compared to scenarios where gross debt is used. Therefore, the unlevered beta and cost of capital will not be greater than the equity beta and cost of capital, making the other options incorrect.

Use the Following Information to Answer the Question(s)below