The Following Statements About Asset Substitution Are True Except For

question 28

Multiple Choice

The following statements about asset substitution are true except for:

• A) Managers have incentives to use debt finance to invest in higher-risk assets with the expectation of obtaining higher returns for shareholders.
• B) Lenders are willing to share higher returns earned when managers invest in higher-risk projects.
• C) A debt covenant that restricts investment opportunities of the entity can reduce the entity's borrowing costs.
• D) Asset substitution arises when an entity uses borrowed funds to invest in higher risk assets than those agreed upon in the debt contract.

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Definitions:

Investor Ownership

A form of ownership where investors own shares or stakes in a company, giving them certain rights and potentially a share in the profit.

Commission

Commission refers to a fee paid for services or a percentage of sales earned by sales employees or agents on the transactions they facilitate.

Cash Dividends

A form of profit distribution by a corporation to its shareholders, paid in cash from the company's current or retained earnings.

Trading Securities

Financial assets that are purchased by an entity not for long-term investment but rather with the intention to sell them in the near term to make a profit.