If Investors' Aversion to Risk Rose, Causing the Slope of the SML

question 85

True/False

If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

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Definitions:

Annually

Pertaining to events or actions that occur once every year.

Present Value

The present worth of a future sum of money or sequence of cash payments, reduced at a particular rate of interest.

PV

An abbreviation for present value, referring to the value today of a future payment or series of payments, adjusted for a specific rate of return.

Discount Rate

This rate, integral to discounted cash flow analysis, is employed for determining the present value of cash flows expected in the forthcoming periods.