A firm in a declining industry has not been able to identify any positive NPV projects in which to invest. In such a case, firm's management should
A)look for a firm to buy that is in an entirely different industry.
B)increase its use of debt in order to decrease its cost of capital, which might result in positive NPV projects being available.
C)invest any excess cash in U.S. Treasury securities in order to earn at least a small return for the firm's shareholders.
D)pay out excess cash to its shareholders by increasing dividends and/or share repurchases.

Question

Quizplus · Accepted Answer

If the firm has not been able to identify any positive NPV projects in which to invest, then it is best for the firm to return excess cash to its shareholders by increasing dividends and/or share repurchases. This will help maximize shareholder wealth without investing in negative NPV projects. Additionally, it will improve the financial health of the firm by reducing excess cash balances and making the firm less vulnerable to economic downturns. If a firm cannot identify any positive NPV projects in a declining industry, it is best to return the excess cash to shareholders through dividends and/or share repurchases. This will increase the shareholders' wealth and reduce the risk of holding cash in the declining industry. Looking for a firm to buy in an entirely different industry (choice A) may not be feasible or may not result in positive returns. Increasing the use of debt to decrease the cost of capital (choice B) may result in financial distress if the firm is unable to generate sufficient returns to cover the increased debt payments. Investing in U.S. Treasury securities (choice C) may provide a small return, but it does not address the issue of declining industry and does not generate higher returns for shareholders.

A Firm in a Declining Industry Has Not Been Able