The inclusion of bankruptcy risk in firm valuation a. acknowledges that a firm has an upper limit to debt financing b. provides a rationale for a saucer-shaped cost of capital curve c. is ignored in the Independence Hypothesis. The agency problem arises due to the separation of ownership and control in a firm. High interest coverage ratios, compared with the industry standard, suggests unused debt capacity. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock and it will also have a beta which is greater than 1.0.
Preferred stock has some characteristics of both common stock and bonds.
Risk adjusted NPVs are difficult to calculate for many projects because of the difficulty in ascertaining an appropriate Beta for the project. The objective of capital-structure management can be viewed as the endeavor to find the financing mix that will minimize the firm's composite cost of capital and maximize the value of the stock. The clientele effect suggests that firms can change their dividend policy frequently with no potential adverse effect on the firm. All rights reserved.