Which one of the following statements is TRUE?
A) When lenders protect themselves from the risk of asset switching, the firm's WACC can increase.
B) An example of an agency cost is when the board of directors pays a dividend to shareholders.
C) An example of an agency cost is when an attorney hires an expert witness for a trial.
D) An example of asset switching is an option to exchange one piece of real estate for another.
E) Lenders can't legally prevent a firm from engaging in asset switching.

Question

Quizplus · Accepted Answer

When lenders protect themselves from the risk of asset switching, they may require the firm to agree to certain restrictions or covenants, which can increase the firm's cost of capital and therefore increase its weighted average cost of capital (WACC). This is because the lenders want to make sure that the firm doesn't engage in asset switching that could reduce the value of their collateral or security.

Which One of the Following Statements Is TRUE