Consider the following equation for the question(s)below:
E + D = U = A
-Which of the following statements is FALSE?
A)The unlevered beta measures the market risk of the firm without leverage, which is equivalent to the beta of the firm's assets.
B)When a firm changes its capital structure without changing its investments, its levered beta will remain unaltered, however, its asset beta will change to reflect the effect of the capital structure change on its risk.
C)If a firm holds $1 in cash and has $1 of risk-free debt, then the interest earned on the cash will equal the interest paid on the debt. The cash flows from each source cancel each other, just as if the firm held no cash and no debt.
D)The unlevered beta measures the market risk of the firm's business activities, ignoring any additional risk due to leverage.

Question

Quizplus · Accepted Answer

This statement is false because when a firm changes its capital structure without changing its investments, both its levered beta and asset beta will change. The levered beta will change because the cost of equity will change with the change in capital structure, and the asset beta will change because the risk of the assets will be affected by the change in capital structure.

Consider the Following Equation for the Question(s)below