Why do firms prefer not to issue equity?Multiple choice question.New equity increases the liability for dividend payments.Share prices tend to rise when equity is issued.New equity increases the probability of bankruptcy.Share prices tend to drop when equity is issued.
Question
Why do firms prefer not to issue equity?Multiple choice question.New equity increases the liability for dividend payments.Share prices tend to rise when equity is issued.New equity increases the probability of bankruptcy.Share prices tend to drop when equity is issued.
Solution
Firms often prefer not to issue equity for a few reasons. Here are the explanations for each of the options:
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"New equity increases the liability for dividend payments." - This is true. When a company issues new equity, it often comes with the expectation of dividends. This means the company has an increased financial obligation, as it needs to provide returns to a larger number of shareholders.
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"Share prices tend to rise when equity is issued." - This is generally false. In fact, the opposite is often true. When a company issues new shares, it dilutes the value of existing shares, which can lead to a decrease in share price.
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"New equity increases the probability of bankruptcy." - This is generally false. Issuing equity actually decreases the probability of bankruptcy because it reduces the company's debt load. Equity financing is not a liability that needs to be repaid like debt, so it doesn't increase bankruptcy risk.
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"Share prices tend to drop when equity is issued." - This is true, as mentioned in point 2. The issuance of new shares dilutes the value of existing shares, which can lead to a decrease in share price.
So, the reasons why firms prefer not to issue equity are because it increases the liability for dividend payments and tends to drop the share prices.
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