Question

Please answer ASAP: The acceptance of a capital budgeting project is usually evaluated on its own merits. That is, capital budgeting decisions are treated separately from capital structure decisions. In reality, these decisions may be highly interwoven. This may result in:

firms rejecting positive-NPV, all-equity projects because changing to a capital structure with debt will always create negative NPV.

never considering capital budgeting projects on their own merits.

corporate financial managers first checking with their investment bankers to determine the best type of capital to raise before valuing the project.

firms accepting some negative-NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV.

firms never changing the capital structure because all capital budgeting decisions will be subsumed by capital structure decisions.

Answer 1

Using leverage reduces the weighted average cost of capital for the firm.

So the correct answer is:

firms accepting some negative-NPV all-equity projects because changing the capital structure adds enough positive leverage tax shield value to create a positive NPV.