Business, 24.10.2019 23:43 Niaax7803

If investors' aversion to risk rose, causing the slope of the sml to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity. however, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.

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if expectations for long-term inflation rose, but the slope of the sml remained constant, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. therefore, the percentage point increase in the cost of equity would be greater than the increase in the interest rate on long-term debt.

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