Question

Asked Oct 19, 2019

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Is there an easily identifiable debt-equity ratio that will maximize the value of a firm?

Step 1

Theoretically, there exists a debt equity ratio at which the value of the firm gets maximized. However, practically, there is no easy way to to identify a debt-equity ratio that will maximize the value of a firm.

Step 2

When the market conditions are good and favorable, the firms tend to increase leverage. Since markets are good, businesses prosper and the firms are able to service the increased leverage. Hence, there is no bankruptcy or cost of distress. However when the tide turns, and markets become tight and unfavorable, the same level of leverage is not ...

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