Question

A firm's debt to equity ratio varies at times because:

A. a firm will want to sell common stock when prices are low and bonds when interest rates are high.
B. a firm will want to take advantage of timing its fundraising in order to minimize costs over the long run.
C. the market allows extensive leeway in the debt to equity ratio before penalizing the firm with a higher cost of capital.
D. All of the above answers are correct.

Answer 1

The fluctuation in a firm's debt to equity ratio is mostly due to its efforts to time the market for its fundraising activities to minimize long-term costs, which is answer B.

Step-by-step explanation:

A firm's debt to equity ratio may vary over time for several reasons. It is not just a matter of a firm wanting to sell common stock when prices are low and issue bonds when interest rates are high. More importantly, firms strive to time their fundraising to minimize costs over the long term, thereby altering their capital structure. It is essential to consider that the market can offer a level of tolerance towards different debt to equity ratios before it raises the firm's cost of capital due to perceived risk.

The correct answer to why a firm's debt to equity ratio varies at times is B. A firm will want to take advantage of timing its fundraising in order to minimize costs over the long run.