Diploma Practice Test & Exam Prep | Canada

Firms seek an optimal target debt-to-equity ratio by balancing tax shield benefits against bankruptcy costs. Firms prioritize their sources of financing, preferring internal funds first, followed by debt, and finally issuing new equity as a last resort. Modigliani-Miller theorems apply perfectly, meaning the method of financing has no impact on firm value. Firms prefer to issue equity when their shares are overvalued by the stock market to capture a pricing premium.