CASE 1512 Debt versus Equity

The entity theory of equity implies that there should be no need for financial statements to distinguish between debt and equity. Alternatively, proprietary theory implies that such a distinction is necessary and yields information vital to owners and potential stockholders.

Required:

1. Discuss the entity theory rationale for making no distinction between debt and equity.
2. Is entity theory or proprietary theory consistent with modern theories of financethat is, does the firms capital structure make a difference? Explain.