The use of homemade leverage:
A) Optimizes the profitability of a firm.
B) Minimizes the weighted average cost of capital for a firm.
C) Makes the capital structure of a firm irrelevant.
D) Is effective only when investors own shares of all-equity firms.
E) Increases the debt-equity ratio of a firm.

Question

Quizplus · Accepted Answer

Homemade leverage refers to the practice where investors adjust their own leverage by borrowing or lending money on their own, rather than relying on the firm's capital structure decisions. According to the Modigliani-Miller theorem, in a world without taxes, bankruptcy costs, and other market imperfections, the capital structure of a firm is irrelevant to its value. This is because investors can create their desired level of leverage independently, making the firm's choice of capital structure irrelevant to its overall value.

The Use of Homemade Leverage