Series 79 practice questionhardDividend Policy and Capital Structure
A company funds a large special dividend by issuing new debt. Which of the following is a likely result?
- ALower expected returns for equity holders
- BDecrease in leverage and increased financial flexibility
- CIncrease in financial leverage and risk to existing creditors✓ Correct answer
- DImprovement in the company’s interest coverage ratio
Explanation
Why C — Increase in financial leverage and risk to existing creditors
Issuing debt to pay a dividend increases leverage and risk to lenders. It reduces, not increases, coverage ratios and flexibility; equity returns may increase but risk also rises.
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