We discount the cash flows of a levered firm with a different discount rate than the cost of equity of the unlevered firm because:
A)leverage decreases the risk of equity of the firm.
B)leverage changes the unlevered cost of equity.
C)leverage increases the risk of equity of the firm.
D)cost of debt decreases in this setting.
E)default risk increases.

Question

Quizplus · Accepted Answer

Leverage increases the risk of equity of the firm because debt holders have a prior claim on cash flows, making equity riskier and thus requiring a higher return.

We Discount the Cash Flows of a Levered Firm with a Different