Question

If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage. True False

Answer 1

It is false that under favorable economic conditions an investor would likely prefer a firm with a low degree of leverage; rather, higher leverage could result in amplified returns.

Step-by-step explanation:

False. If economic conditions are expected to be favorable, an investor might actually prefer a firm with a higher degree of leverage. Leverage involves using borrowed funds to finance investments, and when economic conditions are positive, higher leverage can amplify the returns on investment. Businesses with high leverage can take advantage of the favorable market to expand rapidly and generate greater profits, thus providing potentially high returns for investors. Conversely, during a downturn, high leverage can increase a firm's risk of bankruptcy due to the challenges in meeting debt obligations with reduced revenues.

Answer 2

The statement is false because during favorable economic conditions, investors may prefer companies with higher leverage due to the potential for amplified returns. Leverage can be advantageous when profits are high, as seen during economic upswings like the technology boom of the late 1990s.

Step-by-step explanation:

The statement that an investor would likely prefer a firm with a low degree of leverage if economic conditions were expected to be favorable is false. Leverage refers to the amount of debt a company uses to finance its operations. When economic conditions are favorable, firms are more likely to generate higher profits, making the servicing of debt easier. Therefore, investors may actually prefer companies with higher leverage during such times because leverage can amplify returns.

For example, during the technology boom of the late 1990s, the demand for financial capital shifted to the right, indicating increased confidence and a willingness to take on debt for potentially high-return investments. In contrast, during downturns, such as the Great Recession of 2008 and 2009, firms' demand for capital shifted to the left, signaling a preference for less debt due to the higher risks involved when economic conditions are poor.