When a firm's investment decisions have different consequences for the value of equity and the value of debt, managers may take actions
A)that benefit shareholders at the expense of debt holders.
B)to reduce fixed costs.
C)to increase debt values.
D)to decrease costs of distress.

Question

Quizplus · Accepted Answer

When investment decisions have different consequences for the value of equity and debt, managers may prioritize actions that benefit shareholders (holders of equity) at the expense of debt holders. This is because the value of equity increases with higher risk, while the value of debt decreases with higher risk. Therefore, managers may take on riskier investments that benefit equity holders (e.g. higher potential returns) but may put debt holders at risk (if the investment fails and the firm is unable to make debt payments).

When a Firm's Investment Decisions Have Different Consequences for the Value