Final answer:
The assertion that an investor would prefer a firm with low leverage in favorable economic conditions is false, as higher leverage can enhance returns on equity during economic expansions and when interest rates are low.
Step-by-step explanation:
The statement 'If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage' is false. In favorable economic conditions, a firm with a higher degree of leverage could be more attractive to investors because leverage can increase the returns on equity when operating income rises. Essentially, leverage magnifies the effects of changes in revenue on the profits of a firm. If a firm has a record of high profits, it signifies its ability to repay debt, making the leveraged investment more appealing.
Moreover, when interest rates are lower, a firm's debt is relatively cheaper, enhancing the benefits of leverage. Therefore, during times of economic growth and low-interest rates, many firms and investors believe in the higher returns that can come from borrowed financial capital, as witnessed during the technology boom of the late 1990s. However, it is essential to note that excessive leverage can lead to significant risks if economic conditions deteriorate, as seen during the 2008 and 2009 Great Recession.