Which of the following statements is FALSE? Debt holders are not foolish—they re

Question

Which of the following statements is FALSE?

Debt holders are not foolish—they recognize that when the firm defaults, they will not be able to get the full value of the assets. As a result, they will pay less for the debt initially.

The costs of financial distress represent an important departure from Modigliani and Miller's assumption of perfect capital markets.

Levered firms risk incurring financial distress costs that reduce the cash flows available to investors.

When securities are fairly priced, the original shareholders of a firm pay the future value of the costs associated with bankruptcy and financial distress.

Explanation / Answer

Levered firms considers all financial costs like interest payment in future. These costs reduce the cash flows available to investors.

Debtholders will pay less debt initially when they estimate that there is no chance to get the full value of the assets.

According to Modigliani and Miller's assumptions, given second statement is correct.

First three statements are correct.

Last statement is false as shareholders never pay the future value of the costs associated with bankruptcy and financial distress even there are securities are fairly priced.

Hence, Answer is D option.

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