I need to comment on the following statements:
1. "The less a company needs to raise capital to finance expansion, the more money it should borrow. Instead it is those companies that need to raise new capital that should shun debt, preferring equity".
2. "Because both bondholders and stockholders demand higher rates of return on more highly leveraged firms, a company that uses less financial leverage can reduce both its cost of debt and its cost of equity. Therefore, reducing a company's debt ratio is an easy way to boost its value"
** Please see the attached file. **
COMMENT FROM STUDENT:
I am not sure I understood both answers:
Question 1. Why would a company that needs to raise new capital prefer equity?
Question 2. If the debt ratio is reduced than the value of the company should go up.
UPDATE FROM OTA:
Both of those statements are incorrect.
1. Debt is preferred because interest cost can be written off.
2. Similarly, if the debt ratio is reduced the value of the firm will decrease, since debt is more beneficial due to the ...
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