The inclusion of bankruptcy risk in firm valuation

Question

Quizplus · Accepted Answer

Including bankruptcy risk in firm valuation recognizes that a firm can only take on a certain amount of debt before the risk of bankruptcy becomes too high. This affects the optimal capital structure for the firm, as too much debt financing can result in higher bankruptcy risk and a higher cost of capital. Thus, it has practical implications for capital structure policy. Choices B and C are incorrect as they do not accurately describe the impact of including bankruptcy risk on the cost of capital curve. Choice D is also incorrect as including bankruptcy risk has clear consequences for managing a firm's capital structure.

The Inclusion of Bankruptcy Risk in Firm Valuation