Capital structure in a perfect market
3 important questions on Capital structure in a perfect market
How can a firm enhance its value?
By choosing positive-NPV projects that are worth more than their initial investment.
If a change in leverage raises a firm's earnings per share, should this cause its share price to rise in a perfect market?
No. Even though the firm's earnings per share increase with leverage, due to the additional risk, shareholders will demand a higher return. These effects cancel out, so the price per share is unchanged.
True or false: When a firm issues equity, it increases the supply of its shares in the market, which should cause its share price to fall.
False. As long as the firm sells the new shares of equity at a fair price, there will be no gain or loss to shareholders associated with the equity issue itself. The money taken in by the firm as a result of the share issue exactly offsets the dilution of the shares.
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