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:

Vertical Analysis

A method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities, and equities) is represented as a proportion of the total account.

Comparative Income Statement

A financial statement that presents the revenues, expenses, and net income for multiple periods side by side for comparative purposes.

Sales

Transactions involving the exchange of goods or services for money or its equivalent.

Quick Ratio

A financial metric that measures a company's ability to meet its short-term obligations with its most liquid assets.